Assume a consumer’s utility function is U = √q1 + 2√q2 and her total income is...

Assume a consumer’s utility function is U = √q1 + 2√q2 and her total income is $90. The price of both good 1 and good 2 is $1.

(a) (5 points) What is the bundle that maximizes this consumer’s utility? What is the consumer’s utility level at that point?

(b) (5 points) Suppose that the price of good 1 drops to $0.50. What is the new bundle that maximizes this consumer’s utility? What is the consumer’s utility at this point? [Note that in class we discussed an increase in price, while here we discuss a drop in price.]

(c) (10 points) What is the total effect on the quantity of good 1 of a drop in the price of good 1? Calculate the income and substitution effect of the drop in the price of good 1.

(d) (10 points) How much income would compensate this consumer for this price change, i.e. how much income would this consumer need to give up in order to be equally well off under the new prices as she was before the prices changed?

Solutions

Expert Solution

Rahul Sunny answered 1 year ago

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