1. Suppose Laurent has $60 per week to spend on food and clothing. The price of food is $4 per unit, and the price of clothing is $6 per unit.
a. Sketch Laurent's budget line on the axes provided.
b. Laurent applies to the local government for food stamps and is given $40 worth of food stamps per week. On the axes, show how the receipt of food stamps affects Laurent's budget line.
c. Suppose that instead of food stamps, Laurent receives $40 in cash per week from a relative. On the axes, show how this gift affects Laurent's budget line.
d. Add appropriate indifference curves to the diagram to show that a gift of $40 in cash could make Laurent better off than the receipt of $40 in food stamps.
2. The price of good X is $2.00 and the price of good Y is $1.00. Last year, the price of good X was $1.00 and the price of good Y was $2.00.
a. If a consumer has $100, draw their budget line (on the same diagram) for each year (label them accordingly).
b. Add as many indifference curves as needed to show a situation in which the consumer is no better or worse off this year than they were last year. Be sure to label their optimal baskets for both years. Explain why what you have drawn is correct.
c. On a new diagram with the two budget lines, add as many indifference curves as needed to show a situation in which the consumer is better off this year than they were last year. Be sure to label their optimal baskets for both years. Explain why what you have drawn is correct.
3. The Pullman Company has a lot of pull in the town of Pullman, Illinois. Everybody in town is identical, and they all work for the company, which pays them each $10 a day. The company runs the government, pocketing all tax revenue for itself. Residents eat apples, which they purchase from a mail order company for $1 apiece. But the company imposes a 100% sales tax, so residents actually pay $2 apiece for apples.
a. Draw the typical resident's budget line between "apples" and "all other goods" (measured in dollars). Draw in the optimum point. Label the corresponding quantity of apples A.
b. Use your graph to illustrate the amount of revenue that Pullman derives from the apple tax. (Hint: How much income do you have left after buying A apples? How much income would you have left if you had bought the same number of apples at the untaxed price of $1 apiece? Where is the difference going?
c. Pullman wants to lower the wage rate to $8 a day. Unfortunately, if residents become any less happy, they will all leave town. However, Pullman has calculated that eliminating the apple tax would be just enough to convince people to stay in town at a wage of $8 a day. Assuming that Pullman lowers the wage and eliminates the tax, draw the new budget
line.
d. True or False: The combined changes described in part (c) leave Pullman neither better nor worse off than before.
4. In January, root beer and orange soda each cost $1 a bottle. Judith's income is $20. She buys 5 root beers and 15 orange sodas. In February, the price of root beer falls to 50 cents, the price of orange soda increases to $2 and Judith's income remains $20, and she still buys exactly 5 root beers. True or False: Root beer is a normal good for Judith.