Question

1. On Monday, you consume 15 eggs and 25 wines. On Tuesday, the price of eggs goes up and the price of wine goes down. The Monday and Tuesday budget lines cross at (20,20). Use indifference curves to justify your answers to the following questions:

a) Might you choose to consume 24 eggs on Tuesday?

b) Can you determine on which day you are happier?

For parts c) and d), assume that you choose to consume exactly 18 eggs on Tuesday.

c) Are eggs a normal or an inferior good for you?

d) Which is bigger, the income effect of the combined price changes or the substitution effect?

2. You have 24 hours a day, which you can allocate between leisure and earning income. True or False: If leisure is an inferior good, your labor supply curve will slope upward. Use indifference curves to justify your answer.

3. Lemonade is produced by a competitive industry where every firm must pay a monthly license fee. It takes one lemon to produce one cup of lemonade and each firm produces 40 cups of lemonade per month. One day two things happen at exactly the same time:

• The price of lemons falls by $1 per lemon and

• The license fee rises by $50 per month.

In the short run, can you determine what happens to the quantity of lemonade sold at Lorna’s Lemonade stand? Be sure to indicate how your answer accounts for both the change in the price of lemons and the change in the license fee.

Answer 1