Maya divides her income between coffee and croissants (both of which are normal goods). An early frost in Brazil causes a large increase in the price of coffee in the United States. a. Show the effect of the frost on Maya's budget constraint. b. Show the effect of the frost on Maya's optimal consumption bundle assuming that the substitution effect outweighs the income effect for croissants. c. Show the effect of the frost on Maya's optimal consumption bundle assuming that the income effect outweighs the substitution effect for croissants.

When studying consumer choice theory, the term budget constraint signifies the limit to what consumers like Maya can purchase, restricted by their income and the prices of goods. In simple terms, it is the combination of goods and services a consumer can afford. The budget constraint is often represented graphically by a straight line on a graph where each axis represents the quantity of one good. The line slope reflects the trade-off between the two goods given their prices.

When the price of coffee increases due to an event like an early frost, this constraint shifts. For Maya, who enjoys both coffee and croissants, this shift means she can now afford less coffee for the same amount of money, tilting her budget line inward on a graph. Therefore, Maya must make choices to adjust her consumption within the constraints of her budget, which could involve buying fewer cups of coffee, more croissants, or finding a balance between the two.

The substitution effect occurs when consumers respond to a price change by consuming more of a lower-priced good and less of a higher-priced one. It's a natural reaction to the altered cost-benefit analysis that shoppers like Maya make. When the price of coffee goes up, Maya might decide that croissants are now a more attractive option because they offer more utility per dollar spent compared to the now more expensive coffee.

This shift leads to a move along the indifference curve in a consumption graph to a new optimal consumption bundle where Maya's preference for maximum satisfaction (or utility) meets her adjusted budget constraint. Essentially, she's substituting croissants for coffee due to their relative price change, aiming to maximize her satisfaction given her constrained budget.

Conversely, the income effect describes how a change in the price of a good affects consumer demand via changes in the consumer's real income (purchasing power). When the price of a normal good like coffee increases, Maya's real income is effectively reduced because she cannot afford as much as before, and she feels poorer even if her income hasn't changed nominally.

For normal goods, which are products that consumers would buy more of if they had a higher real income, this could result in buying less of both coffee and croissants. The income effect manifests in the consumption choice of individuals after accounting for the substitution effect. It reflects a shift in the consumption bundle towards less of both goods if income is the dominant factor, and it represents the reduction in Maya's purchasing power due to the price increase.

The combination of goods that Maya selects given her preferences and budget constraints is known as a consumption bundle. It's the particular mix of coffee and croissants that she chooses to purchase. The optimal consumption bundle is the point at which Maya's budget line touches one of her indifference curves, denoting the highest level of satisfaction she can achieve with her available budget.

The optimal consumption bundle will vary depending on the relative strength of the substitution and income effects. If the substitution effect dominates, Maya may end up with a bundle including more croissants. If the income effect is stronger, she might reduce her overall consumption of both goods. The key takeaway is that the optimal bundle is not static; it's influenced by both external factors like price changes and internal factors like Maya's preference and income.

In Maya's case, both coffee and croissants are categorized as normal goods, which are types of goods for which demand increases when consumers' income increases. Similarly, when there is a decrease in real income - as in the case where coffee becomes more expensive, and Maya feels poorer - the demand for normal goods typically decreases.

Understanding the classification of goods as normal is crucial when applying consumer choice theory. It helps predict how changes in income and prices can affect consumer behavior. The essence here is that normal goods like coffee and croissants follow the general pattern of consumption: as wealth grows, so does demand for these items; when wealth contracts, so too does their demand, assuming all other factors remain equal.