Assume an individual has a utility function of this form U(C, L) = 40 + 5(CxL)...

Assume an individual has a utility function of this form U(C, L) = 40 + 5(CxL) This utility function implies that the individual’s marginal utility of leisure is 5C and her marginal utility of consumption is 5L. The individual has an endowment of V=$40 in non-labour income and T = 18 hours to either work (h) or use for leisure (L). Assume that the price of each unit of consumption good p=$2 and the wage rate for each hour of work w=$20.

(a) Calculate the rate at which the individual is willing to sacrifice an additional leisure hour when she is already working 6 hours.

(b) What is this individual’s optimal amount of consumption and leisure?

(c) Suppose that the market wage rate for each hour of work goes up from w=$20 to w=$22. Discuss how you would determine whether the substitution effect or income effect dominates in response to this wage increase. (In answering this part you do not need to do the actual calculations but you need to describe each step you would use)

Expert Solution

Rahul Sunny answered 1 year ago

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Assume an individual has a utility function of this form U(C, L) = 40 + 5(CxL)...

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