Question

1. Consider the utility function: u(x1,x2) = x1 + x2. Find the corresponding Hicksian demand function. 2. For each of the three utility functions below, find the substitution effect, the income effect, and the total effect that result when prices change from p =(2, 1) to p' = (2,4). Assume the consumer has income I = 20. (a) Before doing any calculation, make an educated guess about the relative magnitude of the three substitution effects and the three income effects to be found below. (b) u(x1,x2) = x1 + x2. (c) u(x1,x2) = X1X2- (d) u(x1,x2) = min (x1,x2). (e) Rank the substitution effects and the income effects found above by their magnitude. To what extent do they conform to your guess? 3. A firm that is located in country H, where price levels are p = (1,2), needs to send one of its two employees to its branch in country F. However, in country F price levels are p' = (3,1), so the firm will have to pay additional salary to ensure that its employee is equally well-off in country F as she was in country H. Suppose the utility functions of the two employees are u1(x1,x2) = lnxı +Inx2 and u2(x1,x2) = x1 + x2. The two employees are otherwise identical, including current salary. If the firm wants to minimize the additional salary it needs to pay, which employee should it send? Explain.

Answer 1

ans (1)

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