Principles of Economics, 7th Edition (MindTap Course List)
Principles of Economics, 7th Edition (MindTap Course List)
7th Edition
ISBN: 9781285165875
Author: N. Gregory Mankiw
Publisher: Cengage Learning
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Chapter 21, Problem 6QR
To determine

The budget constraint of the consumer.

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Jerry spends his entire budget on bread and gasoline. His preferences are complete, transitive, monotonic, and convex. For Jerry, bread is an inferior good that follows the law of demand. Moreover, his cross-price elasticity of demand for gasoline with respect to the price of bread is negative. Suppose the price of bread increases, all else constant. a. Create a chart to show the total, income, and substitution effects on bread and gasoline of the increase in the price of bread. b. Use budget lines and indifference curves to graphically illustrate the three effects. Be sure to label each effect on your graph (or through the chart from part a) and plot bread on the x-axis and gasoline on the y-axis
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Problem 2 Marty purchases two goods, food and clothing. He has a diminishing marginal rate of substitution of food for clothing. Let x indicate the amount of food consumed and y the amount of clothing. Suppose the price of food increases from P, to P2. On a clearly labeled graph, illustrate the income and substitution effects for each of the following scenarios: a) Food is a normal good. b) The income elasticity of food is zero (i.e. Marty's consumption of food does not change in response to his income). c) Food is an inferior good, but not a Giffen good. This question is based on problem 5.9 from Besanko and Breautigam. You can (but don't have to) assume that Marty's consumer choice problem has an interior solution both before and after the price change.
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