Charlie’s utility function is U(x1, x2) = x1x2, where x1 and x2 are the Charlie’s consumption...

Charlie’s utility function is U(x1, x2) = x1x2, where x1 and x2 are the Charlie’s consumption of banana and apple, respectively.

The price of apples is $1, the price of bananas is $2, and his income is $40.

(a) Find out the Charlie’s optimal consumption bundle. (Note that Charlie’s utility function is Cobb-Douglas.)

(b) If the price of apples now increases to $6 and the price of bananas stays constant, what would Charlie’s income have to be in order to be able to just afford his old bundle.

(c) Based on (b), measure the changes in Charlie’s consumption of apple due to the substitution effect and the income effect.

Solutions

Expert Solution

Rahul Sunny answered 1 year ago

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