Problem Set 3 Solutions

If the mrs is bigger y utility curves bc initial bc

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Unformatted text preview: e zero. If the MRS is bigger Y UTILITY CURVES! BC initial BC utility compensated BC after price change than the price ratio before and after a decrease in Px, then there is only an income effect: the consumer still consumes only X, but now consumes more of it. 2. Measuring income and substitution effects a) You increase consumption of apples by 0.1. To see this, subtract the initial consumption of apples (X = 1 + 0.1m - 0.3px + ε) from the new consumption of apples, which in this case is Xnew = 1 + 0.1(m + 1) - 0.3px + ε. You will obtain Xnew – X = 0.1. The intuition here is that you have one extra dollar of income, but you only spend 0.1 of your income on apples. Hence you will only spend $0.10 on your extra dollar on apples. You can also see this by differentiating X with respect to m. b) Again, subtract the initial consumption of apples (X = 1 + 0.1m - 0.3px + ε) from the new consumption of apples, which in this case is...
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