ECON 256: Intermediate Microeconomics
Short Assignment: 3
1
Answer Key
Due Date: Thursday, October 28, 2010
1. (a) The following graph shows John’s budget constraints and indifference curves with
respect to two goods: freshcut flower and candy bars. John spends $150 on these two
goods. Initially the price of a flower bunch is $10 and a 5lbs bag of candy bars is $10. Label
this initial budget constraint in the graph as BC
0
. And label John’s initial optimal
consumption bundle as
X.
Now due to a shortage in world sugar supply, the price of candy
bars go up and the new price of a 5lbs bag of candy bars is $30. Label the new budget
constraint in the graph as BC
1
. And label John’s new optimal consumption bundle as
Y.
Note that all the relevant consumption bundles are already identified in the graph; you only
need to label which one is X and which is Y
.
You can label the remaining identified
consumption bundle as Z.
(b) Now labeling the Hicksian budget constraint (BC
H
) in the graph, clearly
identify in the
graph
and
describe in words below
the total, substitution, and income effects of the price
increase in candy bars. To show the effects graphically, you can draw vertical lines from the
consumption bundles and then show the three effects.
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View Full DocumentECON 256: Intermediate Microeconomics
Short Assignment: 3
2
Total effect: X (4, 11) to Y (2, 9)
Substitution effect: X (4, 11) to Z (1.5, 15)
Income effect: Z (1.5, 15) to Y (2, 9)
(c) How much change (increase/
decrease
– underline one) in income is equivalent to the
income effect on the price increase in candy bars? _
$45
___
(d) From your analysis above, can you say whether candy bar is a normal or inferior good?
Explain your answer.
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 Fall '05
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 Microeconomics, candy bar, Reynolds Wrap

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