4. Sam consumes green eggs and ham. Ham and green eggs are both normal goods.
a. Draw an indifference curve and budget constraint where Sam is consuming an optimal combination of the goods. Draw your indifference curve such that green eggs and ham are neither perfect substitutes nor perfect complements (exhibit diminishing marginal rates of substation). Put green eggs on your x-axis and ham on your y-axis.
b. One day the price of green eggs falls. On your graph in part a, show what happens to Sam's budget constraint, indifference curve, and optimal consumption of green eggs and ham.
c. Using words, what is meant by the substitution effect and income effect due to a change in the price of green eggs? (In your answer, note if anything else is held constant.)
d. Identify on your graph, the substitution effect, income effect and total effect for both ham and green eggs due to the price of green eggs changing.
e. In a chart or in words, describe the substitution effect, income effect and total effect for both ham and green eggs due to the price of green eggs changing.
EXTRA CREDIT CHALLENGE
Suppose in 2008 a Census Bureau report indicated that over 62 percent of the U.S. population is covered by employer-sponsored health insurance plans. Consider an employee who does not receive employer-based health insurance and must divide her $1000 per week in after tax income between health insurance and "all other goods." Draw this worker's budget constraint if the price of health insurance is $125 per week and the price of "all other goods" is $100 per week. (Label it BC1.) On the same graph, illustrate the budget constraint if the employer agreed to give this employee $125 worth of health insurance per week (under current tax laws, this form of compensation is nontaxable). (Label it BC2.) On the same graph, show the budget constraint if the employer just gave her a $125 a week raise that was taxable at a rate of 25%? (Label it BC3.) Would any or all employees be better or worse off with the pay raise instead of the health insurance? Explain.