EXERCISE 2

Ravi has 21 to spend on pastries and biscuits. If he spends all the money on pastries, he can afford 15 pastries. The slope of Ravi's budget line (assuming his pastries consumption is measured on the horizontal axis and his biscuits consumption is measured on the vertical axis) is -3.5 (3.5 in absolute terms).

1. Calculate the price of a pastry and the price of a biscuit. Write down Ravi's budget equation and draw the corresponding budget line. Mark the consumption bundle mentioned above. In your graph, clearly label the axes, the budget line, and calculate the coordinates of the points of intersection of the budget line with each axis. Interpret each of those points.
2. Discuss how Ravi's budget set would change if his budget doubles. Show the relevant changes graphically. How could the price of a pastry increase so that Ravi could still afford to buy 15 pastries?
3. Discuss how Ravi's budget constraint would change if the government imposed a tax of 0.50 per pastry and 0.50 per biscuit.