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(solution) 1. Emily's income is $120. She spends her entire income on books.


1. Emily's income is $120. She spends her entire income on books. Emily considers paperback and electronic books to be perfect substitutes, and she is always indifferent between one paperback book and one electronic book. Initially, the price of a paperback book is $15 and the price of an electronic book is $10. Then the price of a paperback book falls to $8. Which of the following statements is true?

A. For paperback books, the income and substitution effects have opposite signs.

B. For paperback books, both income and substitution effect are zero.

C. For paperback books, the income effect is 3 and the substitution effect is 12.

D. For paperback books, the income effect is 4 and the substitution effect is 9.


2. Consider a consumer with preferences:

    u(x,y)=xy, (MUx=y, MUy=x),

facing prices Px=2 and Py=1 and having an income of M=24. Assume now that the price of good X increases to P'x=8.0. Calculate the substitution effect of the demand of good x associated with this price change. No unit, no rounding.


3. Consider a consumer with preferences
      U(x,y)= 2?x + y, (Mux=1/?x, MUy=1)
These preferences have a declining MRSxy. Assume that Px=1 and Py=1 and that the consumer has an income M=100. Calculate the income effect associated with good x if the price of good x increases to P?x=2. No units no rounding.

 


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