301lec6a

301lec6a - Econ 301 Professor S. Severinov Lecture 6...

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Unformatted text preview: Econ 301 Professor S. Severinov Lecture 6 Expenditure Function. You are a young Economist working for the government. In view of the recent price increases, your boss asks you to figure out how to compensate seniors by giving them extra income. The bosss goal is to compensate the seniors so that they are at least as well off as they were before. How to determine how much extra in- come does a consumer need to compensate for an increase in some prices , or for an increase in all prices which is not propor- tional? (If all prices increase in the same proportion the problem is easy: increase in- come by the same proportion). 1 Formally consider the following situ- ation. Initially, the consumer has income I and faces prices p 1 ,...,p n . Suppose now that prices change to ( p 1 ,...,p n ). What in- come level I is required to make the con- sumer as well off as she was before? 2 Step 1. Compute the utility level that the consumer has with income I and old prices p 1 ,...,p n . This is done by solving our standard consumer maximization problem: max x 1 ,...,x n u ( x 1 ,...,x n ) subject to: p 1 x 1 + ... + x n p n I. The solution to this problem is demands (or optimal quantities) x * 1 ( p 1 ,...,p n ,I ),..., x * n ( p 1 ,...,p n ,I )....
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301lec6a - Econ 301 Professor S. Severinov Lecture 6...

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