Mr. Consumer allows himself to spend $100 per month on cigarettes and ice cream. Mr. C’s preferences for cigarettes and ice cream are unaffected by the season of the year.
(a) In January, the price of cigarettes was $1 per pack, while ice cream cost $2 per pint. Faced with these prices, Mr. C bought 30 pints of icecream and 40 packs of cigarettes. Draw Mr. C’s January budget line with blue ink and label his January consumption bundle with the letter J.
(b) In February, Mr. C again had $100 to spend and ice cream still cost
$2 per pint, but the price of cigarettes rose to $1.25 per pack. Mr. C consumed 30 pints of ice cream and 32 packs of cigarettes. Draw Mr. C’s
February budget line with red ink and mark his February bundle with the letter F. The substitution effect of this price change would make him buy (less, more, the same amount of) ________ cigarettes and (less, more, the same amount of) ________ice cream. Since this is true and the total change in his ice cream consumption was zero, it must be that the income effect of this price change on his consumption of ice cream makes him buy (more, less, the same amount of) ________ ice cream. The income effect of this price change is like the effect of an (increase, decrease) ________ in his income. Therefore the information we have suggests that ice cream is a (n) (normal, inferior, neutral) ________ good.
(c) In March, Mr. C again had $100 to spend. Ice cream was on sale for $1 per pint. Cigarette prices, meanwhile, increased to $1.50 per pack. Draw his March budget line with black ink. Is he better off than in January, worse off, or can you not make such a comparison? ________. How does your answer to the last question change if the price of cigarettes had increased to $2 per pack? ________.