Consider a household with the income I and two goods to choose from – square feet of housing (x1) and dollars of other consumption (x2). The annual price per square foot of housing is p, and the household’s tastes can be described by the utility function u(x1,x2)= x1 0.3 x2 0.7 .

a) How much housing and other goods will the household demand as a function of p and I.

b) Suppose income is $120,000 and the price of housing is $12 per square foot. Then the government introduces a subsidy that lowers the housing price to $6 per square foot. In the attached graph, let the solid lines denote the budget lines of the household before and after the subsidy. What are the values of the intercept terms a, b and c in the graph? 11

c) How much of each good does the household consume at bundle A.

d) Describe the shift of consumption from A to C.

e) How much would the household consume of each good after the subsidy?

 

Transcribed Image Text:

S's other c. h P D B b m 11 e sq ft S's other c. h P D B b m 11 e sq ft