In: Economics
(a) Haris spends all of his income on apples and oranges. He thinks that apples and oranges are perfect substitutes; one apple is just as good as one orange. Apples cost $4 a unit and oranges cost $5 a unit. His income is given by $120 per month. If the price of apples increases to $6 a unit, calculate the (i) Slutsky substitution (ii) Income and (iii) the total effect of a price decrease on the consumption of apples. (b) Now assume that he thinks apples and oranges are perfect complements. Apples cost $4 a unit and oranges cost $5 a unit. His income is given by $120 per month. If the price of apples decreases to $3 a unit, calculate the (i) Slutsky substitution (ii) Income and (iii) the total effect of a price decrease on the consumption of apples.
Let apple be considered as good 1 (x1) and orange as good 2 (x2), The slutsky substitution effect is calculated when x1(p1,p2,m) and when price has changed. so, the SE= x1'(p1',p2,m')-x1(p1,p2,m)
and in the same way income effect will be calculated when ME= x1"(p1',p2,m)- x1'(p1',p2,m'). SE and ME is calculated only using the quantitites of those goods whose price change.
a) u= x1+x2 (perfect substitutes)
b) perfect complements
u=min(x1,x2)