Brenda from Problem 3 now has to make a decision about
how many bagels and how much coffee to have for breakfast.
She has $8 of income to spend on bagels and coffee. Use the
information on her utility given in the table in Problem 3.
a. Bagels cost $2 each, and coffee costs $2 per cup. Which
bundles are on Brenda’s budget line? For each of these bundles, what is the level of utility (in utils) that Brenda experiences? Which bundle is therefore her optimal bundle?
b. The price of bagels increases to $4, but the price of coffee
remains at $2 per cup. Which bundles are now on
Brenda’s budget line? For each of these bundles, what is
the level of utility (in utils) that Brenda experiences?
Which bundle is therefore her optimal bundle?
c. Compare your answers from parts a and b. As the price of
bagels increased from $2 to $4, what happened to the
quantity of bagels that Brenda chose to consume? What
does this imply about the slope of Brenda’s demand curve
for bagels? In words, describe the substitution effect and
the income effect of this increase in the price of bagels.
(Bagels are a normal good.)