1. Set up a utility maximization model to think about the consumption of gasoline and other goods. Assume a utility function U u(C, G) where G is the consumption of gasoline and C is = the consumption of a composite good. a) Write the budget constraint of a representative household with annual income I = $50K and the price of gasoline PG = $3.5 per gallon. b) Draw the budget constraint on coordinates where y-axis is C and x-axis is G. What is the slope of the budget line? c) Demonstrate the utility maximizing choice of the representative household as a tangency point of the budget constraint and an indifference curve. d) Demonstrate the new utility maximizing choice when the price of gasoline (PG) decreases from $3.5 to $2.5. e) Decompose the substitution effect and income effect by drawing an auxiliary budget line. f) Discuss the directions of the substitution effect and income effect.
1. Set up a utility maximization model to think about the consumption of gasoline and other goods. Assume a utility function U u(C, G) where G is the consumption of gasoline and C is = the consumption of a composite good. a) Write the budget constraint of a representative household with annual income I = $50K and the price of gasoline PG = $3.5 per gallon. b) Draw the budget constraint on coordinates where y-axis is C and x-axis is G. What is the slope of the budget line? c) Demonstrate the utility maximizing choice of the representative household as a tangency point of the budget constraint and an indifference curve. d) Demonstrate the new utility maximizing choice when the price of gasoline (PG) decreases from $3.5 to $2.5. e) Decompose the substitution effect and income effect by drawing an auxiliary budget line. f) Discuss the directions of the substitution effect and income effect.
Microeconomics A Contemporary Intro
10th Edition
ISBN:9781285635101
Author:MCEACHERN
Publisher:MCEACHERN
Chapter6: Consumer Choice And Demand
Section: Chapter Questions
Problem 6QFR
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Transcribed Image Text:1. Set up a utility maximization model to think about the consumption of gasoline and other
goods. Assume a utility function U u(C, G) where G is the consumption of gasoline and C is
=
the consumption of a composite good.
a) Write the budget constraint of a representative household with annual income I = $50K
and the price of gasoline PG = $3.5 per gallon.
b) Draw the budget constraint on coordinates where y-axis is C and x-axis is G. What is the
slope of the budget line?
c) Demonstrate the utility maximizing choice of the representative household as a tangency
point of the budget constraint and an indifference curve.
d) Demonstrate the new utility maximizing choice when the price of gasoline (PG) decreases
from $3.5 to $2.5.
e) Decompose the substitution effect and income effect by drawing an auxiliary budget line.
f) Discuss the directions of the substitution effect and income effect.
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