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# onsumer behavior, income and substitution effects

1. A student buys five new college textbooks during his first year at school at a cost of \$80 each. Used books cost only \$50 each. When the bookstore announces that there will be a 10% increase in the price of new books and a 5% increase in the prize of used books, the student's father offers him \$40 extra.

a. What happens to the student's budget line? Illustrate the change with new books on the vertical axis.

b. Is the student worse off or better off after the price change. Explain.

2. Since the price of gasoline has risen significantly, the demand for large SUV's has decreased while the demand for comparatively priced but more economical sedans has increased. Using substitution and incone effect analysis, explain and show graphically what has happened to the market for SUV's.

3. Suppose a firm's cost function is C(q)=4q^2+16. At the market price of \$20, the firm is producing 5 units of output.

a. Find VC, FC, AC, AVC, AFC.
b. Find the output that minimizes AC
c. At what range of prices will the firm produce a positive output.
d. At what range of prices will the firm earn a negative profit.
e. At what range of prices will the firm earn a positive profit.

#### Solution Summary

What happens to the student's budget line? Illustrate the change with new books on the vertical axis.

\$2.19