Demonstrate that the demands obtained in exercise 2.4 are homogeneous of degree zero in prices. Show that doubling prices does not affect the graph of the budget constraint.

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Demonstrate that the demands obtained in exercise 2.4 are homogeneous of degree zero in prices. Show that doubling prices does not affect the graph of the budget constraint.

Exercise 2.4

Let a consumer have preferences described by the utility function

and an endowment of 2 units of good 1 and 2 units of good 2.

a. Construct and sketch the consumer’s budget constraint. Show what happens when the price of good 1 increases.

b. By maximizing utility, determine the consumer’s demands.

c. What is the effect of increasing the endowment of good 1 upon the demand for good 2? Explain your finding.

 

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