Question 3

Consumers have preferences over two goodsxandydenoted byu(x, y) =x+Ayy2

The price of goodxis one and goodyisp. All consumers have incomeM. Consumers have decision utility withA= 2and experience utility withA= 1. A monopolist supplies goodywith marginal cost0.5. Experience utility captures the welfare of consumers. In what follows, concentrate on cases where consumers have enough income so that there is an interior solution, i.e. they consume positive amounts of both goods.

1.(a)Derive the demand function for goody.

2.(b)Derive the monopoly and competitive prices and demands.

3.(c)Is consumer utility higher or lower with monopoly or competition? Explain.

(d) What other considerations might be relevant in deciding whether monopoly or competition is welfare superior in this example?