Maude spends all of her income on delphiniums and hollyhocks.
She thinks that delphiniums and hollyhocks are perfect substitutes; one delphinium is just as good as one hollyhock. Delphiniums cost $4 a unit and hollyhocks cost $5 a unit.
(a) If the price of delphiniums decreases to $3 a unit, will Maude buy more of them?
____ What part of the change in consumption is due to the income effect and what part is due to the substitution effect? ________.
(b) If the prices of delphiniums and hollyhocks are respectively pd = $4 and ph = $5 and if Maude has $120 to spend, draw her budget line in blue ink. Draw the highest indifference curve that she can attain in red ink, and label the point that she chooses as A.
(c) Now let the price of hollyhocks fall to $3 a unit, while the price of delphiniums does not change. Draw her new budget line in black ink. Draw the highest indifference curve that she can now reach with red ink. Label the point she chooses now as B.
(d) How much would Maude’s income have to be after the price of hollyhocks fell, so that she could just exactly afford her old commodity bundle
A?
(e) When the price of hollyhocks fell to $3, what part of the change in Maude’s demand was due to the income effect and what part was due to the substitution effect?