3. Use the Cobb-Douglas utility function and budget constraint below to answer questions that follow.

u(x1, x2) = x 1 x (1) 2

m = p1x1 + p2x2

(a) Suppose there is a change in the price of good 1 from p1 to p 0 1 , wherep 0 1 < p1. Diagram the consumers initial optimal choice and their choice after the change in p1.

(b) Redraw your diagram from part 3a and show the substitution and income effects of the change in p1 (i.e. add these to your diagram and clearly label them).

(c) Explain the substitution effect induced by p 0 1 < p1.

(d) Explain the income effect induced by p 0 1 < p1.