Problem Set No. 3

1. Use the diagram below to answer the questions. Assume that income is \$10 and that all income is spent on goods X and Y.

a. What is the price of each of the two goods corresponding to each of the two budget constraints?

b. What does the diagram show?

c. Use the information in this diagram to find two points on this consumer's demand curve for good X.

2. You are a development economist trying to decide how people in Lower Slobovia will spend their income as the country gets richer. Unfortunately, you only have data on their consumption of rice and croissants. The price of rice is constant at .50 cents per pound, while the croissants cost \$1.00 each. You have the following observations:

 Per Capita Income Rice Consumption (pounds) Croissant Consumption (each) \$10 18 1 \$15 16 7 \$20 14 13

Draw a diagram including:

a. the budget constraints for these three levels of income

b. the consumption bundles chosen

c. indifference curves that make these chosen bundles plausible.

Are these goods normal goods or are they inferior? Explain. Can both goods be normal? Can both goods be inferior?

3. You are having some people over for dinner. Unbeknownst to them, you are actually buying ready-made chicken cacciatore and lasagna at the fancy new counter in your grocery store. You can't decide of which to buy more. The chicken is \$4.00 per serving, while the lasagna is \$2.50 per serving. You have \$20 left after you bought everything else. Half-servings are available at half the price of a serving.

a. What is your budget constraint? Write it below.

b. Your guests are good friends. In fact, you know them so well that you know their preferences (that is, their indifference curves) for lasagna versus chicken. (Note that your friends don't care how much you pay for the food. Their preferences are completely independent of prices or income.) Draw the budget constraint on this graph. How much chicken and how much lasagna will you buy? (Half-portions are available at half of the price, so try to get either whole or half servings. Chicken servings are on the vertical axis)

c. All of a sudden, the store clerk tells you that the price of the lasagna is not \$2.50; you had been looking at the label for the macaroni and cheese. The lasagna is actually \$4.00 per serving. Draw the new budget constraint on the same diagram. How much will you buy of each now?

Chicken = Lasagna =

d. The store clerk, seeing how unhappy this price increase has made you, takes pity. For you, the price will be \$2.00 per serving. Draw this budget constraint on the same diagram. Now how much of each will you buy?

Chicken = Lasagna =

e. All of a sudden, you realize that your introductory economics course back at the University actually applies to real-life situations! Just for the fun of it, you decide to sketch out your demand curve for lasagna. Do that here:

f. Oops! You shouldn't have wasted your time on economics! While you were doodling, the clerk's supervisor arrived. The supervisor says that you must pay the \$4.00 per serving for the lasagna; however, if you buy more than 3 servings, she will let you have the additional lasagna for \$2.00 per serving. On the first graph, draw this new budget constraint. (Hint: You should get a kinked line.) How much chicken and lasagna will you now buy?

Chicken = Lasagna =

g. You are exhausted. Instead you decide to order out some pizzas and not shop at this store again.