Re: income and substitution effect problem.

Posted by shiva on Dec 09, 2016; 2:47pm
URL: http://discussion-forum.276.s1.nabble.com/income-and-substitution-effect-problem-tp7602966p7602992.html

Ashish,

The process in which you solved is applicable to convex utility functions, so you got the correct answer when you solved it for u(x,y)=xy

whereas as u(x,y)=(x^2+y^2)^1/2 is a CONCAVE utility functions in which having both (x,y) is not preferable only one of the product is preferred in which case it will have a boundary optimum.

To understand this, plot an indifference curve and the budget equation.

so at this prices px=2 and py = 1, you will have x = 0 and y = 20

whereas at prices px = 0.5 and py = 1, you will have x =40 and y = 0.