Pam spends her money on bread and Spam, and her indifference curves obey the four properties of indifference curves for ordinary goods. Suppose that, for Pam, Spam is an inferior, but not a Giffen, good; bread is a normal good. Bread costs $2 per loaf, and Spam costs $2 per can. Pam has $20 to spend.
a. Draw a diagram of Pam’s budget line, placing Spam on the horizontal axis and bread on the vertical axis. Suppose her optimal consumption bundle is 4 cans of Spam and 6 loaves of bread. Illustrate that bundle and draw the indifference curve on which it lies.
b. The price of Spam falls to $1; the price of bread remains the same. Pam now buys 7 loaves of bread and 6 cans of Spam. Illustrate her new budget line and new optimal consumption bundle in your diagram. Also draw the indifference curve on which this bundle lies.
c. In your diagram, show the income and substitution effects from this fall in the price of Spam. Remember that Spam is an inferior good for Pam.