John eats rice that costs $5 per pound and pasta that costs $10 per pound. The relative
Question:
John eats rice that costs $5 per pound and pasta that costs $10 per pound. The relative price of 1 pound of pasta is 2 pounds of rice. At their current prices, John consumes 1 pound of pasta and 2 pounds of rice. Due to some technological advances in rice cultivation, there has been a fall in rice prices from $5 a pound to $2 a pound. The relative price of 1 pound of pasta has now increased from 2 pounds of rice to 5 pounds of rice. a. Assuming both goods are normal, graphically show John's behavior before and after the fall in rice prices, by clearly indicating: i. John's initial optimum choice ii. John's new optimum choice b. In words, what impact do income and substitution effects have on John's decision? (Hint: Explain each effect's mechanism separately)
Expert Answer:
a Graphical Representation i Johns Initial Optimum Choice Before the fall in rice prices Johns initi... View the full answer
