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Let the utility function be given by u(x1, x2) = √x1 + x2. Let m be the...

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Economics

Let the utility function be given by
u(x1, x2) = √x1 + x2.


Let m be the income of the consumer, P1 and P2 the prices of good 1and good 2, respectively.
To simplify, normalize the price of good 1, that is P1 = £1.


(a) Write down the budget constraint and illustrate the set offeasible bundles using a figure.


(b) Suppose that m = £100 and that P2 = £10. Find the optimalbundle for the consumer. In other words, find the combination of x1and x2 that maximizes the consumer’s utility when the prices are p2= £10, p1 = £1 and her income is m = £100.


(c) Suppose still that m = £100 but now the price of good 2 hasincreased to p2 = £30. Find the optimal bundle for the consumer. Inother words, find the combination of x1 and x2 that maximizes theconsumer’s utility when the prices are p2 = £30, p1 = £1 and herincome is m = £100.


(d) How can we explain the drastic change in demand for the goodswhen the price of good 2 increased from £10 to £30?

Answer & Explanation Solved by verified expert
3.8 Ratings (689 Votes)
D there is a drastic change in consumption when price of x2rises from    See Answer
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