Selina purchases two goods, bottle water and fruits. She has a diminishing marginal

rate of substitution of bottle water for fruits. Let x denote the amount of bottle water

consumed and y the amount of fruits. Suppose the price of bottle water increase from

PX1 to PX2. On a clearly labeled graph, illustrate the income and substitution effects of

the price change on the consumption of bottle water for each of the following cases:

i) Bottle water is a normal good. (5 marks)

ii) The income elasticity of demand for bottle water is zero. (5 marks)

b) Assume a firm's market demand is given by D(P) = 25 0.25P and market supply is

given by S(P) = 0.2P 2.

i) What are the market equilibrium price and quantity? (3 marks)

ii) What is producer surplus at the market equilibrium?