Question

Intermediate Microeconomics. Please show work for each section. Thank you.

EXERCISE 3 Consider a consumer who consumes two goods and has utility function U(X1, X2) = x2 + VX1. Income is m, the price of good 2 is 1, and the price of good 1 changes from p to (1+t)p. Compute the compensating variation, the equivalent variation, and the change in consumer's surplus for a change in the price of good 1, holding income and the price of good 2 fixed.

Answer 1

Due to the change in pices of the goods consumed, a utility receiver by the consumer from the consumption of these goods can be affected.For example,in a two normal good economy and fixed income with monotonic preferences for both goods, increase in the price of one of the goods would lead to less consumption of that good which may decrease the consumer utility.

Compensating variation, is the adjust in income that returns the consumer to the original utility after an economic change has occured.Equivalent variation is a slightly different concept which suggests the amount of income adjustment that should be made with the consumer before the price change to give himthe oiginal level of utility as well be after the change in price.Consumer surplus is defined as the difference between maximum willingness to pay for a good by the consumer and the price that he actually ends up paying for it.