Question

In: Economics

In a typical month, a family buys six bags of candy bars as snacks when the...

In a typical month, a family buys six bags of candy bars as snacks when the price of a bag costs $4.00. When the price of the candy bars falls to $3.00 a bag, the family buys seven bags of candy bars a month. When the price of a bag of candy bars rises to $6.00, the family buys three bags a month.

Answer these questions:

(a) how did the fall in the price affect real income in terms of bags of candy bars?

(b) How did the rise in the price affect real income in terms of bags of candy bars?

[Hint: How many bags of candy bars could the family buy-in situation (a) and in situation (b) without changing the amount they spend on candy bars in a typical month?]

Draw a budget line that reflects the change in the price of candy.

**Please answer all parts of the question!**

Solutions

Expert Solution

Suppose that the family can allocate its income between two goods:

candy bars and
other goods

Now for candy bars,

when P = $4, Q = 6

when P = $3, Q = 7

when P = $6, Q = 3

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(a) how did the fall in the price affect real income in terms of bags of candy bars?

The fall in price increases the real income, in terms of bags of candy bars.

When P = $4, and Q = 6, the family spends $24

When P = $3, and Q = 7, the family spends $21. In real terms, with $24, the family can now buy 8 bags of candy bars.

Thus, real income has increased by 2 bags of candy bars.

---

(b) How did the rise in the price affect real income in terms of bags of candy bars?

The rise in price decreases the real income, in terms of bags of candy bars.

When P = $4, and Q = 6, the family spends $24

When P = $6, and Q = 3, the family spends $18. In real terms, with $24, the family can now buy 4 bags of candy bars.

Thus, real income has decreased by 2 bags of candy bars.

---

(c) Draw a budget line that reflects the change in the price of candy.

Suppose that bags of candy bars are represented on the Y-axis, and other goods on the X-axis. The budget constraint always shows quantities on the axes.

Suppose that the total income of the family is $24. They can spend the entire money on candy bars, or on other goods, or a combination of the two.

The price of the other goods doesn't change. The price of candy bars changes from $3 to $4 and to $6 per bag.

The relevant budget constraints are shown on the graph. The budget constraint shows a rotation, as the price of candy bars changes.

Rahul Sunny answered 2 years ago

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