4. The price of cheese rises from $6 to $10 per kilogram, while the price of wine remains $3 perglass. For a consumer with a constant income of $3000, show what happens to consumption ofwine and cheese if they are both normal goods. Decompose the change into income andsubstitution effects

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Asked Nov 14, 2019
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4. The price of cheese rises from $6 to $10 per kilogram, while the price of wine remains $3 per
glass. For a consumer with a constant income of $3000, show what happens to consumption of
wine and cheese if they are both normal goods. Decompose the change into income and
substitution effects
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4. The price of cheese rises from $6 to $10 per kilogram, while the price of wine remains $3 per glass. For a consumer with a constant income of $3000, show what happens to consumption of wine and cheese if they are both normal goods. Decompose the change into income and substitution effects

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Expert Answer

Step 1

A rise in price from $6 per kg to $10 per kg results in budget line declining from 500 to 300 on horizontal axis. Budget line moves from BC1 to BC2 and optimal choice goes from point A to B.

In order to decompose this change into income and substitutions effects, budget constraint BC3 must be drawn parallel to BC2. BC3 is drawn parallel to BC2 but tangent to consumer...

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wine 1,000 W3 W1 W2 B ВСз вс BC2 0 500 (hilse С2 Сз 300 C1

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