For each of the following, graphically decompose the total effect of the price change into the substitution and income effects on a well-annotated graph. Be sure to clearly label each of the three effects. 2. Paula’s preferences for goods x and y are given by the utility function, U = x 1/2 y 1/2 . Her income is $160, and the price of good y is always $20. Suppose the price of x starts at $20 and then decreases to $5. a. Calculate the income, substitution, and total effects of the price decrease on both goods. Show your work for full credit and round to 2 decimal places where appropriate.
For each of the following, graphically decompose the total effect of the
2. Paula’s preferences for goods x and y are given by the utility function, U = x 1/2 y 1/2 . Her income is $160, and the price of good y is always $20. Suppose the price of x starts at $20 and then decreases to $5.
a. Calculate the income, substitution, and total effects of the price decrease on both goods. Show your work for full credit and round to 2 decimal places where appropriate.
b. Use a clearly labeled graph to illustrate the total, income, and substitution effects of the price decrease on Paula’s consumption of goods x and y.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
