=+6.16 Policy Application: Cost of Living Adjustments of Social Security Benefits: Social Security payments to the elderly are adjusted every year in the following way: The government has in the past determined some average bundle of goods consumed by an average elderly person. Each year, the government then takes a look at changes in the prices of all the goods in that bundle and raises Social Security payments by the percentage required to allow the hypothetical elderly person to continue consuming that same bundle. This is referred to as a cost of living adjustment or COLA.

A. Consider the impact on an average senior’s budget constraint as cost of living adjustments are put in place. Analyze this in a two-good model where the goods are simply x1 and x2

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