Consider a utility function ???? (X A, X B) = XA XB. Let PA = $3 and
Question:
Consider a utility function ???? (X A, X B) = XA XB. Let PA = $3 and PB = $2, and income is set at m = $40. Suppose PB falls to PB′ =1.
a. Before the price change, what was X*A and X*B, the optimal consumption bundles? Sketch the original budget line and label
b. If, after the price change, income changed so that the original optimal bundle is just as affordable. What is the new income (m’)? At (PA, P’B, m’), what is the new optimal bundle (X’A, X’B)? Sketch the budget line associated with (PA, P’B, m’). Label the point (X’A, X’B) as B.
c. Does the substitution effect result in more XB? How many more of fewer? After the price change, how much XA and XB are actually bought, (X’’A, X’’B)? Sketch the budget line associated with (PA, P’B, m). Label the point (X’’A, X’’B) as C.
d. Along the vertical axis, label the income effect, the substitution effect, and the total effect on the demand for XB. The income effect of the fall in PB is the same as an (increase, decrease) in income of $___. (Choose “increase” or “decrease” and supply the missing value.) Does the income effect result in an increased consumption of XB? How much more?
e. Does the substitution effect of the fall in PB make the consumer consume more or fewer XA? How much more of fewer? Does the income effect of the fall in the price of XB make the consumer consume more or fewer of XA? What is the total effect of the change in the price of XB on the demand for XA?
Cost-Benefit Analysis Concepts and Practice
ISBN: 978-1108401296
5th edition
Authors: Anthony E. Boardman, David H. Greenberg, Aidan R. Vining, David L. Weimer