Homer consumes only donuts and beer. When he consumes less than 10 beers, Homer would gladly drink one more. After drinking 10 beers, Homer is so drunk that he does not notice any additional bottle he

Homer consumes only donuts and beer. When he consumes less than 10 beers, Homer would gladly drink one more. After drinking 10 beers, Homer is so drunk that he does not notice any additional bottle he drinks (that is, the benefit of an additional bottle of beer is zero). Drinking more than 17 beers is beyond the processing capability of Homer’s liver and any additional bottle makes him sick (beer is no longer a “good” for Homer). Homer’s preferences for donuts are somewhat similar. As long as he eats less than 15 donuts, an additional donut increases his utility. If he eats more than 15 donuts, then additional donuts make him worse off.

1. Sketch Homer’s indifference curve passing through point (8 donuts, 8 beers).

2. Sketch Homer’s indifference curve passing through point (15 donuts, 16 beers)

   Oranges cost $1/kg and apples cost $0.5/kg. Niki has $12 to spend on apples or oranges. He chooses to buy 10 kg of apples.

3. Draw (on a diagram measuring quantity of oranges on the horizontal axis) Niki’s budget line and show the optimal consumption point. Do not forget to draw the relevant indifference curve(s).

4. The government introduces a tax of 100% on apples (that is, apples now cost $1/kg). How does Niki’s budget line change? Show graphically (on the same diagram you used to answer question 3!) his optimal choice. Can you say whether he will buy more or less apples? Would Niki be better off, or worse off than in question 3?

5. In addition to the tax from question 4, the government has decided to give him a tax rebate (an amount of dollars) that would allow him to continue purchasing the basket from question 3. How large should this tax rebate be? Show (on the same diagram you drew for question 3!) the new budget line and point the new optimal basket. Can you say whether he will buy more or less apples? Would Niki be better off, or worse off than in question 3?

6. Suppose it is possible to buy left shoes for a price of $35/shoe and right shoes for a price of $50/shoe. Alex has an annual budget of $850 for buying shoes, and she has, like most people two feet.

7. Draw Alex’s budget line between left shoes (on the horizontal axis) and right shoes (on the vertical axis). Draw a few of her indifference curves, and show her optimal choice. How many left shoes and how many right shoes does she buy?

8. Now suppose the price of right shoes falls to $15/shoe. Draw (on the same diagram you used to answer question 8!) her new budget line. What is her optimal choice? How many left shoes and how many right shoes will she buy?

9. Show (on the same diagram you used to answer question 8 and 9!) the income effect and the substitution effect caused by the fall in the price of right shoes on her consumption of left shoes.

10. True or False. Left shoes are an inferior good for Alex

11. Suppose from now on that instead of an income of $12, Niki owns 10 kg of apples and 7 kg of oranges, which he can sell at the original prices ($1/kg for oranges and $0.5/kg for apples), if he desires so. Draw (on a new diagram!) Niki’s budget line.Hint: whatever the prices of oranges and apples are, Niki can always afford to consume 10 kg of apples and 7 kg of oranges, simply by not selling or buying any fruits.

12. Suppose that the price of apples increases to $1/kg. Draw Niki’s budget line and show the new optimal consumption basket. Can you say for sure whether Niki would increase his consumption of oranges?