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Instructor: Justin Krieg
Econ 251 – Problem Set 3
1.
Consider the budget line below.
Income is $100 per month, and the price of the x good is
$10 and the price of the y good is $10.
Please answer the following questions.
Be sure to define relative price and
marginal rate of substitution in your answer and use them in your explanation.
b. Graph the new budget line if the price of the x good falls to $5.
Find the new bundle
(
29
2
2
,
x
y
graphically that maximizes utility given the change. Assume that y is a normal good and x is an
inferior (NON giffen) good. Explain why you have chosen the specific values of
(
29
2
2
,
x
y
[relative
to the original equilibrium] given the income and substitution effects related to these goods.
c. Graph the new budget line if the price of the x good rises to $20.
Find the new bundle
(
29
3
3
,
x
y
that maximizes utility given this change. Assume that both x and y are normal goods.
For you new hypothetical maximum bundle indicate possible income and substitution effects for
the x good.
0
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 Summer '08
 Blanchard

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