PROBLEM 1.

Nick works at an office and buys only coffee and bread.

1. Draw Nick's initial budget constraint (BC1)

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Problem 1. Nick works at an office and buys only coffee and bread. 1. Draw Nick's initial budget constraint (BC,). 2. Suppose Nick's income increases. Show the effect with his new budget constraint (BC2). 3. Show what happens to Nick's optimum if, for him, bread is a normal good and coffee inferior good. Label initial optimum A and second optimum B. Problem 2. Inigo divides his income between banana and bread. A typhoon damaged banana plantations causing a large increase in the price of bananas. 1. Show the effect of the typhoon on Inigo's budget constraint. 2. Show the effect of the typhoon on Inigo's optimal consumption bundle assuming that the substitution effect has the same extent of effect with income effect. 3. Show the effect of the typhoon on Inigo's optimal consumption bundle assuming that the income effect outweighs or dominates the substitution effect for bread