Consider the following three graphs, which illustrate the preferences of three consumers (Bob, Carol, and Ted) regarding two goods, apples and peaches. Each consumer has an income of $30, and each consumer pays $2 for apples and $3 for peaches.

a. Suppose that the price of peaches falls to $2. Draw a new budget line for each consumer and find the new optimal bundle of apples and peaches each would buy. How does the new quantity of peaches compare to the original quantity? Indicate the change in the first column of the table on the next page (an increase of one unit might be denoted as a +1).
b. For each consumer, determine the substitution effect of the price change by drawing a hypothetical budget line with the same slope as your new budget line, but just tangent to the consumer's original indifference curve. How much of a change in peach consumption does the substitution effect account for? Indicate that change in the first column of the table on the next page.
c. Now add in the income effect. Compare each consumer's peach consumption in (b) to his or her final peach consumption in (a). Indicate the difference in column 3 of the table on the next page. Doublecheck your work to ensure that the last two columns add up to the number in the first column.
d. Do Bob, Carol, and Ted consider peaches normal, inferior, or income-inelastic?

Transcribed Image Text:

(a) Bob (b) Carol (c) Ted Apples 15 Apples 15 Apples 15 10 10 10- U2 5 5 5 Ui 0 123 15678 5 101 12131415 1 2 3 4 5 6 7 89 1011 12131415 Peaches 23 4578 101 1213145 0 12 3678 5 101 1213141 1 234 5 6 7 8 9 1011 12131415 Peaches Peaches Total Income Effect Substitution Effect of Price Effect of Price of Price Change Change Change Bob Carol Ted