By how much would his income have to increase/decrease to have the same effect?
Increase of
$10
per day
Does the income effect make him consume more bananas or fewer?
How much is the change in consumption of bananas?
(f) Does the substitution effect of the fall in the price of bananas make Charlie consume
more or fewer apples?
How many more/fewer apples does Charlie consume?
Does the income effect of the fall in the price of bananas make Charlie consume more or
fewer apples?
What is the total effect of the change in the price of bananas on the demand for apples?
Exercise 2
1)
2
This gives us the point (
x
*
1
, x
*
2
) = (
1
4
p
2
, m

1
4
p
). This point is indeed in the interior when
x
*
2
>
0, or equivalently when
p >
1
4
m
.
Shall we check the corners as well? Note that the function
u
(
x
1
, x
2
) =
x
2
+
√
x
1
is concave.
Thus, the preferences are strictly convex. And so if we find an interior solution to the FOC’s,
this solution is indeed globally optimal. Thus, we do not actually need to check the corners for
p >
1
4
m
.
What about the situation when
p
≤
1
4
m