1. Regular- and extra-strength pain killers are perfect substitutes; one extra-strength tablet is equivalent to two regular-strength tablets. In each of the following cases, show graphically the effect of a compensated increase in the price of regular-strength tablets. Does this change alter the consumption of regular- or extra-strength tablets? What do your answers tell you about the size of the substitution effects resulting from increases in the price of regular-strength tablets? (LO1)
The price of an extra-strength tablet is more than twice the final price of a regular-strength tablet.
The price of an extra-strength tablet is more than twice the initial price of a regular-strength tablet, but less than twice the final price.
The price of an extra-strength tablet is less than twice the initial price of a regular-strength tablet.
2. Sam currently earns $30,000 a year. The government is considering a policy that would increase Sam's income by 12 percent, but raise all prices by 8 percent. What isSam's compensating variation for the proposed policy? Can you compute it without knowing his preferences? Why or why not? (LO2)
3. Beatriz enjoys writing and uses a large amount of paper. Currently, paper costs $2 for 100 sheets. The formula for her demand curve is S = 525 - 50PS, where PS is the price of 100 sheets and S is the number of sheets purchased. Her provincial government has proposed taxing paper at the rate of $0.50 for each 100 sheets. Assume that this policy would increase the price of paper to $2.50 (including tax). (LO2)
Draw Beatriz' demand curve. Using the method described in Section 6.2, compute the change in her consumer surplus for the proposed tax increase.