Description

1. Answer all parts (a)-(d) of this question.

Let the utility function be given by

u(xi,x2) =

Let m be the income of the consumer, Pl and P2 the prices of good 1 and good 2, respectively.

To simplify, normalize the price of good 1, that is Pi = £1.

(a) [5 marks] Write down the budget constraint and illustrate the set of feasible bundles using

a figure.

(b) [11 marks] Suppose that m = £ loo and that P2 = £10. Find the optimal bundle for the

consumer. In other words, find the combination of x1 and x2 that maximizes the consumer’s

utility when the prices are P2 = £10, Pi = £1 and her income is m = £100.

(c) [11 marks] Suppose still that m = £100 but now the price of good 2 has increased to

P2 = £30. Find the optimal bundle for the consumer. In other words, find the combination of

Xi and X2 that maximizes the consumer’s utility when the prices are P2 = £30, Pl = £1 and

her income is m = £100.