(240)-343-2585

Alix views coffee and cream as perfect complements. In the first period, Alix picks an optimal bundle of coffee and cream, e1. In the second period, inflation occurs, the prices of coffee and cream change by different amounts, and Alix receives a cost-ofliving adjustment (COLA) based on the Consumer Price Index (CPI) for these two goods. After the price changes and she receives the COLA, her new optimal bundle is e2. Show the two equilibria in a figure. Is she better off, worse off, or equally well off at e2 compared to e1? Explain why. By how much will a CPI for these two goods differ from the true cost-ofliving index?