Question

(a) What is the compensating variation? What is the equivalent variation? What is the di⁄erence 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; figure out the compensating variation (CV) associated with price change.

(c) If instead your utility is U(x,y) = ln(x) + y, figure out the compensating 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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