ECON 301 Income and Substitution Effects Gentle Charlie, vegeterian that he is, continues to consume apples and bananas. His utility function is U(Xa,xb)=Xaxb. The price of apples is $1, the price of bananas is $2, and Charlie's income is $40 a day. The price of bananas suddenly falls to $1. a. Before the price change, how many apples and bananas did Charlie consume? On a graph, use black ink to draw Charlie's original budget line and put the label A on his chosen consumption bundle. (Hint: This step involves solving for equilibrium amount of apples and bananas and therefore you need to two equations for two unknowns.) b. If, after the price change, Charlie's income had changed so that he could exactly afford his old consumption bundle (the answer to part a above), what would his new income have been? With this income and the new prices, how many apples and bananas would Charlie consume? Use red ink to draw the budget line corresponding to this income and the new prices. Label the bundle that Charlie would choose at this income and the new prices with the letter B. c. Does substitution effect of the fall in the price of bananas make him buy more bananas or fewer bananas? How many more or fewer? d. After the price change, Charlie actually buys how many apples and bananas? Use blue ink to draw Charlie's actual budget line after the price change. Put the label C on the bundle that he actually chooses after the price change. Draw 3 horizontal lines on your graph, on from A to the vertical axis, one from B to the vertical axis, and one from C to the vertical axis. Along the vertical axis, label the income effect, the substitution effect, and the total effect on the demand for bananas. Is the blue line parallel to the red line or the black line you drew before? e. The income effect of the fall in the price of bananas on Charlie's demand for bananas is the same as the effect of an (increase or decrease? Choose one.) in his income of $_ _ per day. Does the income effect make him consume more bananas or fewer? How many more or how many fewer? f. Does the substitution effect of the fall in the price of bananas on Charlie consume more apples or fewer? How many more or fewer? Does the income effect of the fall in the prices of bananas make Charlie consume more apples or fewer? What is the total effect of the change in the price of bananas on the demand for apples