Question

(a) What is the compensating variation? What is the equivalent
variation? What is the diference between them?
(b) You consume two goods, good x and good y. These goods sell
at prices px = 1 and py = 1, respectively. Your preferences are
represented by the following utility function: U(x; y) = x + ln(y):
You have an income of m = 100. How many units of x and y
will you buy and what will is your utility? If px increases from
$1 to $2; gure out the compensating variation (CV) associated
with price change.
(c) If instead your utility is U(x; y) = ln(x) + y; figure out the com-
pensating variation (CV) as px increases from $1 to $2:
(d) Are the compensating variations the same for both of the above
utility functions? Explain your answer rigorously.

Answer 1

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