✏ L3 Practice - Demand Curve Exercises

✏ Suppose the price of food doubles. In the following diagram, which point, A or B, represents the New consumption bundle? (The other point represents the old consumption bundle)

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A  ✅

✏ Suppose that the budget constraint pivots inward as illustrated in the diagram above. Does consumption of Food Increase or Decrease? Does consumption of Clothing Increase or Decrease? Note that point A is slightly higher than point B.

To answer in the chat room, just enter the underlined letters. For example, if you think Food Increased and Clothing Increased, write FI CI.

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FD CI (ie Food Decreases and Clothing Increases).  ✅

In the question above, you identified the bottom-line change in consumption of Food and Clothes. This is known as the “Combined Effect”. Setting the diagram aside, we can break these changes down into Substitution Effect and the Income Effect.

✏ Setting aside the diagram above, when the price of food doubles, what would the Substitution Effect be for Food and Clothing. (Decrease/Increase)

In the chat room, just enter the underlined letters. For example, if you think that the substitution effect led to an Increase in consumption of Food and an Increase in consumption of Clothing Increased, write FI CI. (As before, put the product (Food or Clothing first and whether it Increased or Decreased second.)

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FD CI (ie Food Decreases and Clothing Increases).  ✅

✏Set aside the diagram above. When the price of food doubles, what would the Income Effect be for Food and Clothing. Assume that both goods are Normal. (Decrease/Increase)

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FD, CD (ie Food Decreases and Clothing Decreases).  ✅

✏ Using your answers above, fill in the Following Table:

	Food	Clothing
Substitution Effect
Income Effect
Combined Effect

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	Food	Clothing
Substitution Effect	↓	↑	SE arrows always go in opposite directions.
Income Effect	↓	↓
Combined Effect	↓	↑

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✏ Kim only buys coffee and compact discs. Coffee costs $0.60 per cup, and CDs cost $12.00 each. She has $18 per week to spend on these two goods. Put coffee on the X axis and CDs on the Y axis. If Kim is optimizing, what is her MRS?

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Version C of our conditions for a consumer optimum is:

$$MRS = \frac{P_x}{P_y}$$$$MRS = \frac{.6}{12} = \frac{1}{20} = .05$$

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