Suppose Clive spends all his money on running shoes and (cups of) tea. Clive’s b

Question

Suppose Clive spends all his money on running shoes and (cups of) tea. Clive’s budget is $50 and the price of shoes is $10. The optimal bundle for Clive varies with the price of tea and is as follows: Case A: (1 pair of shoes, 10 teas) Case B: (2 pair of shoes, 5 teas)

a. According to the information above what is the price of tea in case A and in case B?

b. On a big and precise graph, show the optimal bundle for cases A and B. Then show the substitution effect and the income effect when price of tea changes from case A to case B. Explain what the substitution and income effects are.

c. Do you have enough information to sketch the demand curve for tea? If yes, draw it, if not, explain why. Do you have enough information to sketch the demand curve for shoes? If yes, draw it, if not, explain why.

Explanation / Answer

a. Case A - 4, Case B - 6

b. The demand of tea is expected to increase with the price decrease of tea and vice versa.

c. Yes we can depict them in graph, as two important parameters required, i.e. price and quantity data is available.

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