You have £20 per week to spend, and two possible uses for this money: telephoning friends back home, and drinking coffee. Each hour of phoning costs £2, and each cup of coffee costs £1. Your utility function is U(X,Y) = XY, where X is the hours of phoning you do, and Y the number of cups of coffee you drink. What are your optimal choices? What is the resulting utility level? You can use the standard result on the constrained maximization of such a function, but must state it clearly. Now suppose the price of telephone calls drops to £1 per hour. What are your optimal choices? What is the resulting utility level? How much income per week will enable you to achieve the same quantities at the new prices as the ones you chose before? What income will enable you to attain the same utility as you did before? Comment on your answer in the context of equivalent variation and compensating
You have £20 per week to spend, and two possible uses for this money: telephoning friends back home, and drinking coffee. Each hour of phoning costs £2, and each cup of coffee costs £1. Your utility function is U(X,Y) = XY, where X is the hours of phoning you do, and Y the number of cups of coffee you drink. What are your optimal choices? What is the resulting utility level? You can use the standard result on the constrained maximization of such a function, but must state it clearly. Now suppose the price of telephone calls drops to £1 per hour. What are your optimal choices? What is the resulting utility level? How much income per week will enable you to achieve the same quantities at the new prices as the ones you chose before? What income will enable you to attain the same utility as you did before? Comment on your answer in the context of equivalent variation and compensating
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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You have £20 per week to spend, and two possible uses for this money: telephoning friends back home, and drinking coffee. Each hour of phoning costs £2, and each cup of coffee costs £1. Your utility function is U(X,Y) = XY, where X is the hours of phoning you do, and Y the number of cups of coffee you drink.
What are your optimal choices? What is the resulting utility level? You can use the standard result on the constrained maximization of such a function, but must state it clearly.
Now suppose the price of telephone calls drops to £1 per hour. What are your optimal choices? What is the resulting utility level?
How much income per week will enable you to achieve the same quantities at the new prices as the ones you chose before? What income will enable you to attain the same utility as you did before? Comment on your answer in the context of equivalent variation and compensating variation.
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