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SHOW ALL WORK!!! DO NOT ANSWER WITHOUT SHOWING YOUR MATH Exercise 1: Income and Substitution Effect Julia has quasi-linear utility of the form u(x, y)

SHOW ALL WORK!!! DO NOT ANSWER WITHOUT SHOWING YOUR MATH

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Exercise 1: Income and Substitution Effect Julia has quasi-linear utility of the form u(x, y) = f(x) + y (linear in the amount of the second good). With income m = 600 and prices p = 5, q = 10 Julia's optimal bundle is (a*, y*) = (20, 50). When the price of the first good decreases to p' = 2, Julia's new optimal bundle is (a**, y**) = (40, 52).| 1. Follow the steps below to decompose the change in quantity demanded into income and substitution effects using Slutsky's approach: . How much income is needed for the artificial budget m that keeps the Slutsky real income constant? . What is Julia's optimal bundle when faced with the artificial budget m? . Decompose the change from (a* , y*) = (20, 50) to (a**, y**) = (40, 52) into income and substitu tion effects. Compute the sizes of the effects for both goods. Explain your findings. 2. How would your answers to part 1 change if Julia had quasi-linear utility that is linear in the amount of the first good (rather than the second), i.e. u(x, y) = x + g(y)? 3. How would your answers to part 1 change if Julia had a Cobb-Douglas utility function (homothetic preferences), i.e. u(x, y) = C . x . yb

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