Question: Suppose a consumer has a utility function given by U(X,Y) = X + 2Y. The consumer has $20 to spend (M = $20), the price

Suppose a consumer has a utility function given by U(X,Y) = X + 2Y. The consumer has $20 to spend (M = $20), the price of Good Y is PY = $1, and the price of Good X is initially PX = $1. Suppose the Price of X decreases to PX = $0.25. a) How Much X and Y will the consumer buy to maximize utility? X* = ____________ Y* = _____________ b) After the Price Change, how much X and Y will the consumer buy to maximize utility? X** = _____________ Y** = _____________ c) What is the Compensating Variation? CV = _________________ d) What is the Equivalent Variation? EV = _______________ e) Of the total change in the quantity demanded of X, how much is due to the Substitution Effect? SE = ______________

Answers: a) How Much X and Y will the consumer buy to maximize utility? X* = 0 Y* = 20 After the Price Change, how much X and Y will the consumer buy to maximize utility? X** = 80 Y** = 0 c) What is the Compensating Variation? CV = $-10 d) What is the Equivalent Variation? EV = $-20 e) Of the total change in the quantity demanded of X, how much is due to the Substitution Effect? SE = 40

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