Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Joan has preferences over two goods, x and y, that admit the following utility function represen- tation: U(x, y) = xy Joan's constrained optimization problem

Joan has preferences over two goods, x and y, that admit the following utility function represen- tation: U(x, y) = xy Joan's constrained optimization problem is: maxx,y U(x, y) = xy subject to px x + py y = I where px and py are the respective prices of goods x and y and I is income. (a) Derive Joan's demand functions for goods. Your answer should show that quantity de- manded in a function of income and own price. 3 points (b) Suppose that px = py = 1 and that I = 8. What is Joan's optimal bundle? 1.5 points (c) Now suppose that the price of good x doubles to px = 2 while everything else stays con- stant. What is Joan's new optimal bundle? 1.5 points (d) Draw a graph that shows how Joan's behavior changes when the price of x doubles. This graph should show how Joan's changing consumption can be decomposed into income and substitution effects. Please label everything relevant to the problem, including the coordi- nates of the original optimal bundle, the "substitution effect" bundle, and the new optimal bundle. 4 points Note: For a 1/2 point penalty, you may omit calculating the substitution effect bundle. Bonus: Calculate the amount of additional income necessary (Hicksian compensation) necessary to keep Joan on her original indifference curve post price change.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Microeconomics

Authors: Paul Krugman, Robin Wells

4th Edition

1464143870, 9781464143878

More Books

Students also viewed these Economics questions

Question

What do we need in order to value a coupon bond?

Answered: 1 week ago