Bob has $200 in income that he uses to purchase two goods – DVDs of classic movies and skinny ties. The price of a DVD is $20, and the price of a skinny tie is $4.
a. Draw Bob's budget constraint (put skinny ties on the horizontal axis). Bob’s preferences lead him to choose a combination of 4 DVDs and 30 skinny ties. Draw the indifference curve that leads him to this choice. What is his marginal rate of substitution at this point? Explain in words what this means.
b. Now assume Bob teaches an extra filmmaking class at the local community college, and his income doubles. Draw the new budget constraint. What do you think will happen to his consumption of classic movies and skinny ties? (Give a qualitative rather than a numerical answer. Show graphically and be explicit about any assumptions you are making.)
c. Now assume that the price of skinny ties rises to $6 due to a shortage of vintage clothing. Draw Bob's new budget constraint (going back to the original income of $200). What do you think will happen to his consumption of classic movie DVDs? What do you think will happen to his consumption of skinny ties? (HINT: there are multiple possible answers to one of these two questions.] Explain your answer.