Substitution and Income Effect (Calculation) Suppose that the consumer's utility function is Cobb-Douglas U(x; y) =...

Substitution and Income Effect (Calculation)

Suppose that the consumer's utility function is Cobb-Douglas U(x; y) = xy. She initially has $100

income and the prices that she faces are px = py = $2:

a. Compute her demands for x and y.

b. Now suppose that px decreases to $1 while py remains unchanged. Compute her new demands for x

and y.

c. What is the total (price) effect on the consumption of x?

d. What is the substitution effect (SE) and income effect (IE) due to the price change?

Expert Solution

Rahul Sunny answered 1 year ago

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