Jean views coffee and cream as perfect complements. In the first period, Jean pi

Question

Jean views coffee and cream as perfect complements. In the first period, Jean picks an optimal bundle of coffee and cream, e1. In the second period, inflation occurs, the prices of coffee and cream change by dif- ferent amounts, and Jean receives a cost-of-living adjustment (COLA) based on the consumer price index (CPI) for these two goods. After the price changes and she receives the COLA, her new optimal bundle is e2. Show the two equilibria in a figure. Is she better off, worse off, or equally well off at e2 compared to e1? Explain why.

Explanation / Answer

Jean is equally well off at e^2 compared to e1.. Even if coffee becomes relatively cheaper, Jean won’t raise her utility by consuming more coffee because cream and coffee are prefect complements

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