You have 400.000 EUR of disposable income to spend in housing and all other goods. Let...

You have 400.000 EUR of disposable income to spend in housing and all other goods. Let x be the square meter size of your house and y be the expenditure in all other goods. The square meter price is currently p = 1000. We disregard the investment value of housing and just focus on its consumption value (as when you are renting). Let us assume your preferences for housing and all other goods can be represented by a Cobb-Douglas utility function of the form u(x,y) = x*y.

1. Write down the demand functions for housing and all the other goods as functions of price p and income M.
2. Calculate your optimal consumption decision

3. After you purchased the house, the square meter price fell down to p = 500. Suppose you can sell your house at no additional transaction costs. How does this change your situation and your budget line? At price p = 500: Would you sell your house and buy a new one? A bigger or a smaller one? What would your preferences have to look lie, if after the price change you do not want to change anything in the size of your house?

Expert Solution

Rahul Sunny answered 1 year ago

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