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1. Joe’s income is $80. He spends all of it on two goods, bread and water. The price of water is $4 a gallon. The price of bread is $5 a loaf.
a. Draw Joe’s budget line on a graph and label it B1. (Graph bread on the y-axis and water on the x-axis) (1 point)
b. Now there is a drought and the price of water increases to $8 a gallon. Draw Joe’s new budget line on the same graph below and label it B2. (1 point)
c. The government decides to freeze the price of water at $4 and place a limit of 5 gallons of water on each consumer’s purchase of water. Draw Joe’s new budget line assuming the law is perfectly enforced on the same graph and label it B3. Is it possible that this rationing plan will make him better off compared to his level of satisfaction in part b? Explain using indifference curves and the budget lines. (3 points)
Extra credit: On a new graph show the indifference curves for someone who would not be better off with rationing. (2 points)