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Answers to: ECON-314-03/04 Assignment 3 Question 1. Spenser's budget constraint before the 10% sales tax applied to clothing is: Y X P X P f f c c = + , where c P and f P are the prices of clothing and food, respectively, c X and f X are the quantities of clothing and food consumed, and Y is his budget for the two goods. The corresponding budget line in the graph below is BL1. After the 10% sales tax is applied to clothing in his state, the new unit price for clothing is now equal to C C P 1 . 1 P %) 10 1 ( = + . Thus, his budget constraint after the 10% sales tax applied to clothing is now: Y X P X ) P 1 . 1 ( f f c c = + , which corresponds to BL2 in the graph below. Now, because the new budget line rotates inwards, we know for sure that the optimal quantity of clothing demanded by Spenser is less than before (that is, Xc2 < Xc1 in the graph below) but the optimal quantity of food demanded by Spenser could decrease, increase or unchanged depending on the exact location of the new optimal consumption bundle e2. 1

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