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A preference-maximising consumer’s expenditure function is e(p1, p2, u) = p2(4p1u − p2)/ 4p1 . Suppose...

A preference-maximising consumer’s expenditure function is

e(p1, p2, u) = p2(4p1u − p2)/ 4p1 .

Suppose that the prices of the goods are initially p 0 1 = 1, p 0 2 = 4, and that the consumer’s income is $120. The prices change to p 1 1 = 2, and p 1 2 = 2 with no change in the consumer’s income.

Find the consumer’s consumption bundles at the initial and new prices. For each commodity, partition the change in consumption into the substitution effect and the income effect.

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Answer #1

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