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This problem shows that an optimal consumption choice need not be interior and may be at a corner point.) Suppose that a consumer’s utility function is U(x, y) = xy + 10y. The marginal utilities for

This problem shows that an optimal consumption choice need not be interior and may be at a corner point.) Suppose that a consumer’s utility function is U(xy) = xy + 10y. The marginal utilities for this utility function are MUxy and MUyx + 10. The price of x is Pxand the price of y is Py, with both prices positive. The consumer has income I.

a) Assume first that we are at an interior optimum. Show that the demand schedule for x can be written as x = I/(2Px) − 5.

b) Suppose now that I = 100. Since x must never be negative, what is the maximum value of Pxfor which this consumer would ever purchase any x?

c) Suppose Py= 20 and Px= 20. On a graph illustrating the optimal consumption bundle of x and y, show that since Pxexceeds the value you calculated in part (b), this corresponds to a corner point at which the consumer purchases only y. (In fact, the consumer would purchase y = I/Py= 5 units of y and no units of x.)

d) Compare the marginal rate of substitution of x for y with the ratio (Px/Py) at the optimum in part (c). Does this verify that the consumer would reduce utility if she purchased a positive amount of x?

e) Assuming income remains at 100, draw the demand schedule for x for all values of Px. Does its location depend on the value of Py?

Apr 16 2021 View more View Less

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