Douglas Cornfield’s demand function for good x is x(px, py,m) = 2m/5px. His income is $1,000, the price of x is $5, and the price of y is $20. If the price of x falls to $4, then his demand for x will change from 80 to 100.
(a) If his income were to change at the same time so that he could exactly afford his old commodity bundle at px = 4 and py = _____ what would his new income be? ____. What would be his demand for x at this new level of income, at prices px = 4 and py = 20? ____.
(b) The substitution effect is a change in demand from 80 to 92. The income effect of the price change is a change in demand from _____ to ____.
(c) On the axes below, use blue ink to draw Douglas Cornfield’s budget line before the price change. Locate the bundle he chooses at these prices on your graph and label this point A. Use black ink to draw Douglas Cornfield’s budget line after the price change. Label his consumption bundle after the change by B.
(d) On the graph above, use black ink to draw a budget line with the new prices but with an income that just allows Douglas to buy his old bundle, A. Find the bundle that he would choose with this budget line and label this bundle C.