In: Economics
Emily likes to drink wine and eat cheese. Her preferences are given by U(W,C) = min{5W,C}
Emily has $150, wine costs $8 and cheese costs $2.
a. What is her optimal consumption bundle?
b. Suppose that the price of wine goes up to to $10.
c. Break down the effect of this change into income and substitution effects. Depict this in a graph.
d.What is the equivalent variation of this price change? Explain what it means
e. What is the compensating variation of this price change? Explain what it means
show all work
a) at eqm, 5W = C
From BC : 8W + 2C = 150
Put , C = 5W
So, 8W + 10W = 150
18W = 150
W*= 8.33
So, C*= 5*W*= 41.667
B) PW'= 10
so, from new BC : 10W + 2C = 150
Put C = 5W
So, 10W + 10W = 150
W"= 150/20= 7.5
C"= 37.5
c) as two goods are consumed in a fixed proportion, so Substitution effect is zero
entire Effect is income effect.
Graph
d)