Charlotte spends her income of $2400 on clothing (good x), and the composite good (good y...

Charlotte spends her income of $2400 on clothing (good x), and the composite good (good y ). The utility Charlotte receives from consuming a basket of clothing and the composite good is, U(x, y ) = 2√ x + y 300. The corresponding marginal utilities are, MUx = 1 √ x and MUy = 1/ 300.
(c) Find Charlotte’s optimal consumption basket when the price of clothing is Px1 = $50, and the price of the composite good is Py = $1.

(d) Find Charlotte’s optimal consumption basket when the price of clothing increases to Px2 = $60 (the price of the composite good remains Py = $1).

(e) Find the income and substitution effects for the price increase. Is clothing a normal good? Briefly explain

Solutions

Expert Solution

c) Optimal bundle is found by equating the slope of the indifference curve to that of the budget line, and substituting the values in the budget line. The working is shown as follows.

d) Same process is followed, except that the values are changed.

Clothing is a normal good. This is because when a consumer's income increases, the demand for clothing increases. In economic jargon, a positive income elasticity of demand. When the income is more, the consumer will obviously spend more on essentials like clothing. Therefore a positive income elasticity of demand is achieved. Hence it is a normal good.

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Rahul Sunny answered 2 months ago

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