Eco_1_problem_set_7 - Eco 1 Spring 2008 This problem set is...

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Eco 1 Spring 2008 Problem Set 7 This problem set is due in your recitation. 1) Consider the following consumption bundles, made up of combinations of cookies and milk: Consumption Bundle Glasses of milk Cookies Total Cost A 0 10 $5.00 B 1 8 $5.00 C 2 6 $5.00 D 3 4 $5.00 E 4 2 $5.00 F 5 0 $5.00 A) Using cookies on the horizontal axis, construct a Budget Constraint for consumption based on this information (and assuming our milk-and-cookie budget is $5.00). Identify the bundles on the Budget Constraint. B) We are told that (i) Bundle D maximises our utility subject to our Budget Constraint, (ii) We are indifferent between Bundle D and Bundle G (G = 4 glasses of milk and 3 cookies), but we cannot afford Bundle G. We can afford Bundle E, but that gives us less utility than Bundles D or G. Using Indifference Curves, illustrate these three bundles (either on the graph above, or a new graph below). C) Now suppose the price of cookies has doubled. Show the effect on the Budget Constraint, and where the new optimum combination of cookies and milk will most likely occur.
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