**Utility and Budget Analysis of Office Friendly**3. **Office Friendly's Consumption Choices**Office Friendly consumes donuts ($ d $) and other goods ($ c $). His preferences are represented by the utility function:\[ u(d, c) = 8\sqrt{d} + c. \]Office Friendly has a budget of $200 to allocate, with the initial prices being $ p_D = $1 $ and $ p_C = $1 $. Subsequently, the price of a donut increases to $ p_D = $2 $.**Questions to Analyze:**(i) Determine Office Friendly’s optimal consumption bundles before and after the donut price increase.(ii) Calculate the compensating variation corresponding to the increase in the price of donuts.(iii) Assess the equivalent variation resulting from the price change.

Answered: 3. Office Friendly consumes donuts (d)…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

**Utility and Budget Analysis of Office Friendly**

3. **Office Friendly's Consumption Choices**

Office Friendly consumes donuts ($ d $) and other goods ($ c $). His preferences are represented by the utility function:

\[ u(d, c) = 8\sqrt{d} + c. \]

Office Friendly has a budget of $200 to allocate, with the initial prices being $ p_D = $1 $ and $ p_C = $1 $. Subsequently, the price of a donut increases to $ p_D = $2 $.

**Questions to Analyze:**

(i) Determine Office Friendly’s optimal consumption bundles before and after the donut price increase.

(ii) Calculate the compensating variation corresponding to the increase in the price of donuts.

(iii) Assess the equivalent variation resulting from the price change.

Expert Solution

Introduction

Optimal bundle is when MUd / MUc = Pd/ Pc

Where MUd = Marginal utility from donuts and MUc = Marginal utility from other goods.

Compensating variation is such amount of income that is provided to the individual, that the individual attains initial level of utility at new prices i.e. after the price increase of donuts.

Equivalent variation refers to in adjustment of individuals income in such a way that individual attains new level of utility without change in prices.