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Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126

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Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126
Chapter 21, Problem 6QR
Textbook Problem
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The price of cheese rises from $6 to $10 per pound, while the price of wine remains $3 per glass. For a consumer with a constant income of $3,000, show what happens to consumption of wine and cheese. Decompose the change into income and substitution effects.

To determine
The budget constraint of the consumer.

Explanation of Solution

When the wants and needs of a human are unlimited but the budget of an individual is limited, it will lead to a constraint of needs and this constraint raised due to the limited budget is known as the budget constraint of an individual. Thus, budget constraint is defined as the possible combination of goods and services that can be purchased with the entire income at a given price level.

Here, the income of the person is given as $3,000 and the price of per glass wine is $3, and the price of cheese is $6. Thus, when the consumer spends her entire income on the purchase of cheese, the quantity that she receives can be calculated by dividing the income by per pound price as follows:

QuantityCheese received=IncomePer pound price=3,0006=500

Thus, when she spends all her income on cheese, she can buy 500 pounds of cheese. When she spends all her income on the wine, the quantity can be calculated by replacing the price of cheese with that of wine as follows:

QuantityWine received=IncomePer glass price=3,0003=1,000

Thus, when she spends all her income on wine, she can receive 1,000 glasses of wine.

The budget constraint represents all the combinations of these two goods ranging between 500 pounds of cheese and no wine to no cheese, and 1,000 glasses of wine. The vertical axis represents the wine and the horizontal axis represents the cheese on our diagram. The 500 pounds of cheese and no wine point represents the horizontal intercept and the no cheese and 1,000 glasses of wine represents the vertical intercept

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