Question

Stuart's utility function for goods X and Y is represented as U(X,Y)=X0.8Y0.2. Assume that his income is $100 and the prices of goods X and Y are $20 and $10, respectively.

Now a government subsidy program lowers the price of X from $20 per unit to $10 per unit.

(e) Calculate and graphically show the change in good X consumption resulting from the program.

(f) Graphically show the change in consumption attributable to the separate income and substitution effects.

(g) Show (graphically) how much the program cost the government.

Answer 1

(e) let 's use the budget constraint formula:

100=20x+10y

x=5, y=10

100=10x+10y

x=10,y=10