Question

Suppose that Jim uses his budget to purchase 100 units of Good X and 100 units of Good Y. When the price of Good X rises, he purchases 55 units of Good X and 95 units of Good Y. An economist calculates his compensated budget and finds that in that scenario, Jim would buy 60 units of Good X and 105 units of Good Y Calculate the substitution effect Remember to include a negative sign (-) if the effect reduces the quantity) Answer

Answer 1

For substitution effect, we consider the compensated budget line of because compensated budget line considers only substitution effect and no income effect. Thus, impact of price rise on demand of good x considering only substitution effect = demand with compensated budget - initial bundle = 60 -100 = -40 unit U = x^1 y^4, M = $6 The demand 'function of x in case of Cobb-Douglas production function = alpha/alpha + beta times M/p_n when U = x^alpha y^beta x^d = 2/2 + 4 times 6/ P_n = 2/6 times 6/P_n = 2 times 1/P_x The part (c) of the diagram shows that rink is associated at a price land of $ 2