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Paula's preferences for goods x and y are given by the utility function, U = x 1/2 y 1/2 . Her income is $160, and
Paula's preferences for goods x and y are given by the utility function, U = x 1/2 y 1/2 . Her income is $160, and the price of good y is always $20. Suppose the price of x starts at $20 and then decreases to $5.
a. Calculate the income, substitution, and total effects of the price decrease on both goods. Show your work for full credit and round to 2 decimal places where appropriate.
b. Use a clearly labeled graph to illustrate the total, income, and substitution effects of the price decrease on Paula's consumption of goods x and y.
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