Effect of the increase in price on the consumption of good

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Reference no: EM13854073

Consider a consumer with utility function u(x1,x2) = x1x2 and income m who faces given prices p1 and p2.

(a) Derive the demand function of good 1. (b) Whatistheoptimalconsumptionofgood1ifm=8andp1 =p2 =1?

(d) Imagine that the price of good 1 increases to p1 = 4. What is the optimal demand of good one now?

(e) Draw the new budget constraint, optimal choice and indifference curve going through this optimal choice.

(f) What is the effect of the increase in price on the consumption of good 1? How much of this effect in consumption is due to the income effect and how much to the substitution effect?

Reference no: EM13854073

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