You have to include as much diagrams as possible to illustrate your answers. The

by | Jan 13, 2022 | Economics | 0 comments

You have to include as much diagrams as possible to illustrate your answers. The more you use the better. Be very accurate and explicative. Every explication which can be accompanied with a graph is compulsory.
Question 1
Farah has a monthly budget of £250. Farah consumes good D and good E. The price of good D is £10 and price of good E is £2.5.
Her utility function is given by U(Xd, Xe) = Xd*Xe where MUd=Xe and MUe = Xd. She is very worried that the price of good D has increased to £15. She is struggling to understand what she will be able to afford now. Can you help her find out what consumption bundle she should consume now? Show all calculations and plot good D on the x-axis. Mark the optimal bundle she could afford before the price change with A and the new optimal bundle as B.
Farah asks you how much worse-off she is after the price change. What would you tell her?
Farah comes back to you and tells you that she made a mistake. She actually thinks of good D and E as substitutes such that she is indifferent between two units of good E and one unit of good D. Please help her understand in this case what would happen if the price of good D stays at £10 but the price of good E increases to £5. Please write down her utility function, calculate what she was consuming before the price change, what she is consuming now after the price change, and whether she is worse-off, same, or better-off after the price change.
Question 2:
Alice’s economics tutorial has been rescheduled from Tuesday afternoon to 8:30 Monday morning and she is not happy about it. Discuss how the concepts of “compensating variation” and “equivalent variation” could be used to quantify the effect of this timetabling change on Alice’s welfare.
Explain under what conditions “compensating variation” and “equivalent variation” are equal and under what conditions they are not equal


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