Jacques and Simone Girard live in New York and enjoy going out to fancy restaura
ID: 1216801 • Letter: J
Question
Jacques and Simone Girard live in New York and enjoy going out to fancy restaurants for dinner and to diners for breakfast. On the following diagram, the red curves I1 and I2 represent two of their indifference curves for fancy dinners versus diner breakfasts. Their total income to be spent on eating out is $600 per month. The price of a diner breakfast is always $10. The blue lines BL1 and BL2 represent their budget lines if the price of a fancy dinner is $240 or $60, respectively. The green line H is parallel to B12 and is tangent to I1 at point Y. Initially, the price of a fancy dinner is $240, so the budget line is shown by BL1. At this price, the Girards decide to spend on fancy dinners per month (point X). Now, suppose that the price of a fancy dinner decreases to $60. In order to be as happy as they were before the price decrease-that is, to consume at some point on the same indifference curve as they were on initially-the Girards' income spent on fancy dinners and breakfast at diners would have to be The substitution effect of the price decrease causes the Girards to go out to dinner times per month. The income effect of the price decrease causes Jacques and Simone to go out to dinner times each month. Because of the direction of the income effect, you can tell that fancy dinners are the Girards.Explanation / Answer
at BL1 (240 for fancy and 10 for x)
Budget constraint: 10x+240y = 600
10*35 + 240y = 600
y = 1.04
Therefore, total spend on y is 240*1.04 = 250
Now prices reduce to 60
Budget constraint = 10x +60y = 600
10*30 + 60y = 600
y = 5.
Total income spend on x = 300 and y = 300
Substitution effect increase the consumption of y from 1 to 2 and income effect increase it to 5.
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