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1. Cheesy Compensation (4 points) John lives in the Netherlands and very much enjoys gouda cheese. On the accompanying graph, x denotes the number of

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1. Cheesy Compensation (4 points) John lives in the Netherlands and very much enjoys gouda cheese. On the accompanying graph, x denotes the number of pounds of gouda cheese. The composite good y measures his annual consumption of other goods; the price of the composite good is py, which is constant in this problem. Several indifference curves from his preference map are drawn with levels of utility U1, U2, Ug, U4 and Us. If he spends all his income on the composite good, he can purchase y* units, as shown in the graph. When the initial price of gouda cheese is $5 per pound, he can purchase as many as 18 pounds of gouda cheese. Us U4 U3 UL 8 10 12 14 16 18 * 1. Use the graph above to determine the income and substitution effects on the amount of pounds of gouda cheese John buys if the price of gouda cheese increases from $5 to $15. Clearly label these effects on the graph and explain below. 2. Using the graph (reproduced below), estimate the numerical size of the compensating varia- tion associated with the price increase. Explain carefully and illustrate your answer on the graph V * = Us U4 U 3 UL 8 10 12 14 16 18 * 3. Will the consumer surplus measured using John's demand for gouda cheese provide an exact measure of the monetary value he associates with the price increase? In a sentence, explain why or why not

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