Liam spends his budget on books (B) and clothing (C). His utility function is U(B,C)= BC. He has a weekly income of £400, the price of a book is £10, and a unit of clothing costs £20. 1. What is Liam's optimal consumption bundle? Explain and draw a graph to illustrate your computations. 2. Let's now assume that the price of clothing falls to £10. What is his new optimal consumption bundle? Does the substitution effect of this decrease in price make him buy more or less clothing? Does the income effect of this price change make him buy more or less clothing? Justify your answers.
Liam spends his budget on books (B) and clothing (C). His utility function is U(B,C)= BC. He has a weekly income of £400, the price of a book is £10, and a unit of clothing costs £20. 1. What is Liam's optimal consumption bundle? Explain and draw a graph to illustrate your computations. 2. Let's now assume that the price of clothing falls to £10. What is his new optimal consumption bundle? Does the substitution effect of this decrease in price make him buy more or less clothing? Does the income effect of this price change make him buy more or less clothing? Justify your answers.
Principles of Microeconomics
7th Edition
ISBN:9781305156050
Author:N. Gregory Mankiw
Publisher:N. Gregory Mankiw
Chapter21: The Theory Of Consumer Choice
Section: Chapter Questions
Problem 1PA
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Question
For 1, I got c=10 and B=20.
For 2, Substitution effect >> consumption of clothing increases from 10 to 10*sqr10, consumption of book decreases from 20 to 10sqr10
income effect >> the consumption of clothing increases from 10*sqr10 to 20. consumption of book increases from 10sqr10 to 20
Am i right??
Transcribed Image Text:B2 Part 1.
Liam spends his budget on books (B) and clothing (C). His utility function is
U(B,C) = BC. He has a weekly income of £400, the price of a book is £10,
and a unit of clothing costs £20.
1. What is Liam's optimal consumption bundle? Explain and draw a graph
to illustrate your computations.
2. Let's now assume that the price of clothing falls to £10. What is his new
optimal consumption bundle? Does the substitution effect of this
decrease in price make him buy more or less clothing? Does the
income effect of this price change make him buy more or less clothing?
Justify your answers.
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