(a) Haris spends all of his income on apples and oranges. He thinks that apples and...

(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.

Solutions

Expert Solution

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)

Rahul Sunny answered 1 month ago

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