Suppose you allocate all your wealth to "housing" and "savings". Housing costs $40 per square foot. You have $100,000 in wealth and have elected to build a 1000 square foot house.

1. Draw your budget line between housing (on the horizontal axis) and savings (on the vertical). Draw the indifference curve you are on.

Now suppose the price of housing falls to $30 per square foot.

1. Draw your new budget line. (Hint: You can keep your existing house -- the one shown in your answer to question 1 above this one -- if you want to.)
2. True or False: The fall in housing prices makes you happier.
3. Assume that housing is an inferior good and illustrate the substitution and income effects from a fall in housing prices..
4. True or False: If housing is an inferior good, then in this problem the substitution effect must be larger than the income effect.