Review session for Midterm #1

c) Determine the numerical size of the compensating variation (in monetary terms) associated with theincrease in the price of the good from 1 to 4.P F F + P C C = 4(6) + 4(5) = 44. So she would need an additional income of 24 (plus her actual income of 20).The compensating variation associated with the increase in the price of food is‐24.Clothing 111098Initial U765Final UDecomp Basket4Final BL3Initial Basket21FinalDecomp BLInitial BL001234567891011121314151617181920IncEffectSubst Effect = -6Food5.22 There are two consumers on the market: Jim and Donna. Jim’s utility function is U(x,y)=xy, withassociated marginal utilities MU x =y and MU y =x. Donna’s utility function is U(x,y)=x 2 y, with associatedmarginal utility functions MU x =2xy and MU y =x 2 . Income of Jim of I J =100 and income of Donna is I D =150.a) Find optimal baskets of Jim and Donna when the price of y is P y =1 and price of p is x.Jim’s optimal basket is a solution to equationsMU x / MU y = P / P y and P x + P y y = I J .Hence, we have 2xy / x 2 = P and P x + y = 100with solution x = 200 / (3P) and y = 100 / 3.Analogous system of equations for Donna isy / x = P and P x + y = 150 with solution x = 75 / P and y = 75.b) On separate graphs plot Jim’s and Donna’s demand schedule for x for all values of P.Approximate shape of the demand curve for Jim and Donna is depicted below.17