Assignment:
1. A consumer has income of $3,000. Wine costs $3 per glass, and cheese costs $6 per pound.
A. Draw the consumer's budget constraint with wine on the vertical axis.
B. What is the slope of this budget constraint?
C. Draw a consumer's indifference curves for wine and cheese. Describe and explain four properties of these indifference curves.
D. Pick a point on an indifference curve for wine and cheese, and show the marginal rate of substitution. What does the marginal rate of substitution tell us?
E. Show a consumer's budget constraint and indifference curves for wine and cheese. Show the optimal consumption choice. If the price of wine is $3 per glass and the price of cheese is $6 per pound, what is the marginal rate of substitution at this optimum?
F. A person who consumes wine and cheese gets a raise, so her income increases from $3,000 to $4,000. Show what happens if both wine and cheese are normal goods. Next, show what happens if cheese is an inferior good.
G. The price of cheese rises from $6 to $10 per pound, while the price of wine remains $3 per glass. For a consumer with a constant income of $3,000, show what happens to consumption of wine and cheese.
Decompose the change into income and substitution effects.
H. Can an increase in the price of cheese possibly induce a consumer to buy more cheese? Explain.
2. A college student has two options for meals: eating at the dining hall for $6 per meal, or eating a Cup 0' Soup for $1.50 per meal. Her weekly food budget is $60.
A. Draw the budget constraint showing the trade-off between dining hall meals and Cups 0' Soup. Assuming that she spends equal amounts on both goods, draw an indifference curve showing the optimum choice. Label the optimum as point A.
B. Suppose the price of a Cup 0' Soup now rises to $2. Using your diagram from part (A), show the consequences of this change in price. Assume that our student now spends only 30 percent of her income on dining hall meals. Label the new optimum as point B.
C. What happened to the quantity of Cups 0' Soup consumed as a result of this price change? What does this result say about the income and substitution effects? Explain.
D. Use points A and B to draw a demand curve for Cup 0' Soup. What is this type of good called?