Question

TRUE OR FALSE QUESTION please explain the reason briefly （few sentences is okay）

Jon’s utility function is U(a, b) = ab, where a is his consumption of apples and b is his consumption of bananas. If prices and income change in such a way that Jon’s oldconsumption lies on his new budget line, then Jon will not change his consumption bundle.

Answer 1

False, given the Jon's utility function U(a,b)=ab if the price and income change in such a way that Jons old consumption lies on his new budget line then Jon will change the optimal consumption bundle from its original consumption bundle.

The change in price has two effects first effect is a substitution effect and the second effect is income effect.Substitution effect isthat effect which causes change in consumption bundle due to change in the relative price of a commodity whereas the income effect is that effect which causes the change in consumption bundle due to the change in the purchasing power of the consumer. In this case the substitution effect would have cause the optimal consumption bundle to move more towards the consumption bundle which has lower price and income effect would also have cause the change in the optimal consumption bundle according to the change in the purchasing power of the consumer. Thus due to this Jon will not have the same consumption bundle which he earlier has.