2. Consider an individual who not only consumes goods x and y, but also needs a mini-mum amount of x = xo to survive. Her (Stone-Geary) utility function is given byU(x, y) = (x − xo)¹/2y¹/2Let prices be pa, Py and income is I > Prxo. (b) How do the ratios p/I and pyy/I (i.c., budget shares) change as income increases

Answered: (b) How do the ratios prx/I and pyy/I…

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

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Chapter1: Making Economics Decisions

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2. Consider an individual who not only consumes goods x and y, but also needs a mini-
mum amount of x = xo to survive. Her (Stone-Geary) utility function is given by
U(x, y) = (x − xo)¹/2y¹/2
Let prices be pa, Py and income is I > Prxo.

(b) How do the ratios p/I and pyy/I (i.c., budget shares) change as income increases

Expert Solution

Step 1: Utility Maximisation

The individuals maximise their utility at point where the slope of the indifference curve ( Marginal Rate of substitution) is equal to the slope of budget constraint (Relative price ratio).

The utility maximisation condition required satisfaction of the tangency condition and hence the slopes should be equal .

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