Suppose your family's monthly grocery budget is $350. You can use it to by junk food meals for $5/meal or healthy food meals for $7/meal.
- Draw a budget constraint (BC1) for your family's monthly grocery decision. Label the axes clearly.
- What is the opportunity cost of a healthy meal?
- Label the initial consumption point C1 (on the budget constraint) indicating that the family decides to spend half of its budget on healthy food and half on junk food.
- Suppose the price of healthy food drops to $5/meal. Draw the new budget constraint (BC2) next to the old one.
- What is the new opportunity cost of health food?
- Suppose the family responds to this price change by eating more healthy-food meals, increasing to 50 healthy food meals (you will have to adjust consumption of junk food now). Show C2 on the new budget constraint.
- On a new graph, show the family's demand curve for healthy meals, derived from the change in prices. This graph must be clearly labelled and show how a price change affect the change in quantity demanded.
- Describe the likely income- and substitute effects for their healthy-eating behavior.
- Is healthy food a Giffen good here?
Suppose a poor family in China has $10 for food per month. They can purchase rice for calories (to stay alive) or meat for taste. The price of rice is $1/pound and the price of meat is $5/pound.
- Draw the budget constraint (BC1) for this family.
- Suppose they typically consume 9 pounds of rice. Show this point on the BC as C1.
- Suppose a non-profit organization starts giving out rice coupons, cutting the price of rice to $0.75/pound. Show the new budget constraint (BC2) next to the old one.
- Suppose the family responds by buying 1 pound of meat. Show C2 on the new budget constraint. How much rice do they eat now (show on graph).
- On a new graph, show the family's demand curve for rice, derived from the change in prices.
- Describe the likely income and substitute effects for their rice-eating behavior.
- Is rice a Giffen good here?