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microbook_3e-page69 - Eric Doviak Principles of...

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Eric Doviak Principles of Microeconomics Examples of Income and Substitution Effects Case where Donuts are neither a Gross Complement nor a Gross Substitute for Coffee I confess. I’m a Dunkin’ Donuts Junkie. I spend all of my income on coffee and donuts. I earn $100 per week and I spend it all on coffee and donuts. Every week I buy 25 donuts and 25 coffees. But something strange is about to happen in Donut World. The price of donuts has always been $2 and the price of coffee has always been $2, but when I wake up tomorrow, the price of donuts will fall to $1. What a wonderful day! My money income won’t change, but my real income (purchasing power) will be higher since I’ll now be able to purchase more coffee and more donuts. The relative price of donuts will also fall from donut coffee 1 $2/coffee $2/donut to donut coffee 5 . 0 $2/coffee $1/donut and that will suit me just fine as I sink my teeth into a delicious Boston Cream and savor the fact that I now have to give up less coffee to eat more of my favorite donuts.
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