Income SE.docx - (a When the price of good 2 was 1 and income was 90 the quantity demanded of x2 was 40 and when the price of good 2 dropped to 1/2 and

# Income SE.docx - (a When the price of good 2 was 1 and...

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(a) When the price of good 2 was 1 and income was 90, the quantity demanded of x2 was 40 and when the price of good 2 dropped to 1/2 and income was still 90, the quantity demanded of x2 was 84 The change in quantity demanded is: 84-40 = 44 Substitution Effect: When Price of X2 is ½ but utility is constant at 10, then the demand for x2 was 70 So Substitution effect = X2(At P = ½ and U = 10) – X2(At P = 1 and U = 10) = 70 – 40 = 30 Income Effect = X2(At P = ½ and U = 15) - X2(At P = ½ and U = 10) = 84 – 70 = 14 Since substitution effect is positive, thus, X2 is a normal good. (b) Situation 1 P 1 X 1 + P 2 X 2 = I 1*50 + 1*X 2 = 70 X 2 = 20 (Solution) Situation 2 P 1 X 1 + P 2 X 2 = I 1*50 + (1/2)*X 2 = 70 X 2 = 40 (Solution) Situation 3 P 1 X 1 + P 2 X 2 = I 1*X 1 + (1/2)*34 = 58 X 1 = 41 (Solution)

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Question 4 (a) Since both contains water and give equal satisfaction, the only difference will arise due to quantity. 1 bottle of x will give 0.75 utility i.e. equal to quantity and 1 bottle of y will give 2 utility i.e. equal to quantity.
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