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Determining the optimal consumption bundle

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Reference no: EM133078150

Consider your preferences for Gasoline (X) and a composite good (Y). Your utility function is U(X,Y) = X^(2/5 )+ Y^(2/5). You have an annual income of $40,000. Suppose the price of the composite good is $1.

a) Due to shortages, the government has introduced a rationing system such that you can only consume a maximum of 5,000 liters a year at $1 a liter. What would be your optimal consumption bundle?

b) The government removes the rationing system and the free market price of gasoline jumps to $2. What would be your new optimal consumption bundle? Are you better off with or without the rationing? Show by finding the utility levels.

c) Illustrate your solution in a clearly labeled graph.

Reference no: EM133078150

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