Answer to Question #139442 in Macroeconomics for Arundhati Dey

Question

Jennifer divides her income between coffee and croissants(both of which are normal goods). An early frost in Brazil causes a large increase in the price of coffee in India.
a. Show the effect of the frost on Jennifer’s budget constraint.
b. Show the effect of the frost on Jennifer’s optimal consumption bundle assuming that the substitution effect outweighs the income effect for croissants.
c. Show the effect of the frost on Jennifer’s optimal consumption bundle assuming that the income effect outweighs the substitution effect for croissants.

Answer 1

a. Jennifer’s budget constraint will shift to the left.

b. If the substitution effect outweighs the income effect for croissants, then the consumption of coffee will decrease, and the consumption of croissants will be the same or even increase.

c. If the income effect outweighs the substitution effect for croissants, then the consumption of both coffee and croissants will decrease.