Problem
Course: Introduction to Microeconomics
Alexis is best at making terremotos and his secret recipe is that each terremoto should be composed of three quarters (3/4) of pipeño (p) and one quarter (1/4) of grenadine (g) (as it should always be). Alexis buys liters of said beverages ONLY at aforementioned REASON (neither more nor less than any). Prices of these beverages are as follows: price of pipeño, Pp = $4/liter and price of grenadine, Pg = $6/liter. Income Alexis receives is only $36. Since Alexis has just come out of his very complex introductory microeconomics control, he decided to have a party and spend all his income on these two beverages to celebrate.
Given that both goods are NORMAL GOODS and that it is possible to buy fractions of a liter of pipeño and grenadine (they are divisible goods), answer:
1. Find optimal basket that Alexis should buy for party. Graph
2. Now price of grenadine (Pg) has dropped to $2/liter. Find new optimum basket. Graph
3. Find INCOME EFFECT and SUBSTITUTION EFFECT (choose Hicks or Slutzky) in case of grenadine and explain it with economic intuition and graphically.
After buying beverages and preparing "Terremoto" drinks, Alexis got a little hungry. He got himself an extra $20 to buy churrascos or hamburgers. In this case, Alexis is indifferent between two. Price of the churrasco is Pch = $10 and price of hamburger is Ph = $8 and it is possible to buy fractions of both goods (they are divisible goods).
1. What does Alexis consume?
2. If price of hamburger rises to $9, what is Substitution Effect and Income Effect? Choose Hicks or Slutzky and explain your results graphically.
3. If price of hamburger rises from $9 to $11, what would now be Substitution Effect and Income Effect? Choose Hicks or Slutzky and explain your results graphically.