Welfare Measures Consider a consumer with utility function of the form u(x,y) = √xy. Where x...

Welfare Measures Consider a consumer with utility function of the form u(x,y) = √xy. Where x is

the number of hamburgers and y the number of soft drinks.

(a) Find the compensated demands.
(b) Calculate the Compensated Variation (CV) when the price of soft drinks increase from $1 to $4. (Assume that the utility at the original price level is equal to 2 and the price of hamburgers is equal to $4)
(c) Is the consumer better-off or worse-off after the price change? How can you tell?
(d) Calculate the loss in the consumer surplus using the Marshallian Demands for the same price change. (Assume that income is equal to $8 and keep the price of hamburgers constant). Whey are the consumer surplus and the CV different?

Expert Solution

The solution is given as follows:

c. The individual remains on the same indifference curve so he receive same utility of 2 utils even after the price rise if the price rise is followed by a compensation to the individual in terms of increase income. In this case the individual is neither better off or worse off due to price rise, but, if there was no increase in income than the utility of individual will fall and he will be worse off due to this price rise and he will end up in a lower utility curve.

Rahul Sunny answered 1 year ago

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