Answer to Question #281413 in Microeconomics for jawad

Question

The price of cheese rises from $6 to $10 per pound, while the price of coke remains $3 per glass. For a consumer with a constant income of $3,000, show what happens to consumption of coke and cheese

Answer 1

A rise in the price of cheese from $6 to $10 a pound makes the horizontal intercept of the budget line decline from 500 to 300 as below. The budget constraint of the consumer shifts from B1 to B2 and the optimal choice changes from point A to point B. To decompose this change into income and substitution effects, draw a budget constraint B3 parallel to B2 and tangent to the initial indifference curve at point C. The movement from point A to C represents the substitution effect. Because cheese became more expensive, the consumer substitutes wine for cheese as she moves from point A to C. The movement from point C to B is the income effect. The rise in the price of cheese results to a decline in income.