Question

Exercise 3 For Sandra, coffee and sugar are perfect complements: she wants to consume exactly 2 g of sugar for each cup of coffee. She has S6 to spend on sugar and coffee. One gram of sugar costs 5 cents and one cup of coffee costs 20 cents. Draw a diagram, with sugar on the horizontal axis and cup of coffee on the vertical axis, to answer the following questions. 1. Which bundle will Sandra consume (represented by point A)? Hint: Draw and use the equation of Sandra's budget line (BL,). Draw the indifference curve and explain how the tangency condition applies here. 2. The price of the gram of sugar rises to 10 cents. Draw Sandra's new budget line (BL,) along with her first budget line (BL). What is the new consumption bundle (represented by point C)? 3. Show the income and substitution effects from this raise in the price of sugar. Use appropriate diagrams with point B denoting the bundle consumed when only the substitution effect is acting. Tell us whether there is an increase or decrease in the consumption of the two goods under each effect. Now, Sandra's income rises to S8. Draw her new (BL.). Draw an indifference curve that illustrates her new optimal consumption bundle (denoted by point D). Which effecets) is (are) acting here?

Answer 1