Return to the analysis of my undying love for my wife expressed through weekly purchases of roses (as introduced in end-of-chapter exercise 6.4).
A. Recall that initially roses cost $5 each and, with an income of $125 per week, I bought 25 roses each week. Then, when my income increased to $500 per week, I continued to buy 25 roses per week (at the same price).
(a) From what you observed thus far, are roses a normal or an inferior good for me? Are they a luxury or a necessity?
(b) On a graph with weekly roses consumption on the horizontal and “other goods” on the vertical, illustrate my budget constraint when my weekly income is $125. Then illustrate the change in the budget constraint when income remains $125 per week and the price of roses falls to $2.50. Suppose that my optimal consumption of roses after this price change rises to
50 roses per week and illustrate this as bundle C.
(c) Illustrate the compensated budget line and use it to illustrate the income and substitution effects.
(d) Now consider the case where my income is $500 and, when the price changes from$5 to $2.50, I end up consuming 100 roses per week (rather than 25). Assuming quasilinearity in roses, illustrate income and substitution effects.