4. Suppose we have a market for coffee and pastries. a. Graph the market (no need...

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Economics

4. Suppose we have a market for coffee and pastries.
a. Graph the market (no need to give numbers for endpoints ofthe budget constraint) and show an optimal consumption bundle.
b. Suppose the price of coffee drops. Graph the new budgetconstraint.
c. Now, illustrate the INCOME and SUBSTITUTE effects of theprice change and show the new optimum. Remember, you must draw theimaginary budget constraint and then find the tangency on the newbudget constraint.

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3.6 Ratings (574 Votes)

a Suppose we measure coffee along the horizontal axisand pastries along the vertical axis The initial budget line is ABand the initial indifference curve IC1 which is tangent to AB atpoint M with respect to which the initial consumption of coffee isq1 and initial consumption of pastries is X1 Now when the price ofcoffee drops the budget line will rotate outward from AB to ACwhich becomes tangent to the See Answer

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