Question

Don't copy from the other answer! Please write the result for part 2

1. Substitution effect

The Slutsky equation decomposes a change in consumption caused by a price change (income effect and substitution effect). Find the substitution effect of a price change in the following cases:

1. ε^U= -0.7, ε_y =1.4 and budget share (b) = 0.2

2. ε^U= -0.9, ε_y = 0.8 and U = x₁^0.5x₂^0.5

Answer 1

a) the intire change in utility will be because sub situation effect. ep=ep^h-e , ep=ep^h-eyb where ep=uncompensated price elasticity, ep^h=compensated price elasticity, ey=income elasticity, b=budget share ep^h=(-0.7)+1.4x0. 2=-0.42., ep^h=-0.42 thank you