ASSIGNMENT:
CHAPTER 21
1. Jennifer divides her income between coffee and croissants (both of which are normal goods). An early frost in Brazil causes a large increase in the price of coffee in the United States.
a. Show the effect of the frost on Jennifer’sbudget constraint.
b. Show the effect of the frost on Jennifer’s optimal consumption bundle assuming that the substitution effect outweighs the income effect for croissants.
c. Show the effect of the frost on Jennifer’s optimal consumption bundle assuming that the income effect outweighs the substitution effect for croissants.
2. Compare the following two pairs of goods:
• Coke and Pepsi
• Skis and ski bindings
a. In which case are the two goods complements? In
which case are they substitutes?
b. In which case do you expect the indifference curves
to be fairly straight? In which case do you expect
the indifference curves to be very bowed?
c. In which case will the consumer respond more to a
change in the relative price of the two goods?
3. You consume only soda and pizza. One day, the price of soda goes up, the price of pizza goes down, and you are just as happy as you were before the price changes.
a. Illustrate this situation on a graph.
b. How does your consumption of the two goods
change? How does your response depend on in-
come and substitution effects?
c. Can you afford the bundle of soda and pizza you
consumed before the price changes?
7. A college student has two options for meals: eating at the dining hall for $6 per meal, or eating a Cup O’ Soup for $1.50 per meal. Her weekly food budget
is $60.
a. Draw the budget constraint showing the trade-off between dining hall meals and Cups O’ Soup. Assuming that she spends equal amounts on both goods, draw an indifference curve showing the optimum choice. Label the optimum as point A.
b. Suppose the price of a Cup O’ Soup now rises to $2. Using your diagram from part (a), show the con- sequences of this change in price. Assume that our student now spends only 30 percent of her income on dining hall meals. Label the new optimum as point B.
c. What happened to the quantity of Cups O’ Soup consumed as a result of this price change? What does this result say about the income and substitution effects? Explain.
d. Use points A and B to draw a demand curve for Cup O’ Soup. What is this type of good called?
8. Consider your decision about how many hours to work.
a. Draw your budget constraint assuming that
you pay no taxes on your income. On the same diagram, draw another budget constraint assuming that you pay 15 percent tax.
b. Show how the tax might lead to more hours of work, fewer hours, or the same number of hours. Explain.
10. 10. Draw the indifference curve for someone deciding how to allocate time between work and leisure. Suppose the wage increases. Is it possible that the person’s consumption would fall? Is this plausible? Discuss. (Hint: Think about income and substitution effects.)
CHAPTER 22
2. Suppose that the Live-Long-and-Prosper Health Insurance Company charges $5,000 annually for a family insurance policy. The company’s president suggests that the company raise the annual price to $6,000 to increase its profits. If the firm followed this suggestion, what economic problem might arise? Would the firm’s pool of customers tend to become more or less healthy on average? Would the company’s profits necessarily increase?
4. Some AIDS activists believe that health insurance companies should not be allowed to ask applicants if they are infected with the HIV virus that causes AIDS. Would this rule help or hurt those who are HIV-positive? Would it help or hurt those who
are not HIV-positive? Would it exacerbate or mitigate the problem of adverse selection in the market for health insurance? Do you think it would increase or decrease the number of people without health insurance? In your opinion, would this be a good policy? Explain your answers to each question.
10. The government is considering two ways to help the needy: giving them cash or giving them free meals at soup kitchens.
a. Give an argument based on the standard theory of
the rational consumer, for giving cash.
b. Give an argument, based on symmetric information, for why the soup kitchen may be better than
the cash handout.
c. Give an argument, based on behavioral economics,
for why the soup kitchen may be better than the cash handout
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