2. Gentle Charlie, vegetarian that he is, continues to consume apples and banana

Question

2. Gentle Charlie, vegetarian that he is, continues to consume apples and bananas. His utility function is U(xa, xb) = xaxb. The price of apples is $1, the price of bananas is $2, and Charlie’s income is $40 a day.

A. Derive Charlie’s demand functions for apples and bananas. (Hint: you will need to use these functions for parts B - E.) B. What is Charlie’s optimal bundle of apples and bananas given prices, income, and preferences? C. Now assume the price of bananas drops to $1. What is his new optimal bundle? D If, after the price change, Charlie’s income changed so that he could exactly afford his consumption bundle in part B, what would his adjusted level of income be? E. Using the information found in parts A through D, find both the income and substitution effects for the decrease in the price of bananas.

Please answer E!

Explanation / Answer

E. Using the information found in parts A through D, find both the income and substitution effects for the decrease in the price of bananas.

Substitution effect of the fall in price of bananas makes him buy 5 more bananas. After the price change, with the change in income, its effect would be consuming 5 more bananas with an additional 10 per day in his income.

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.