# Utility is given by U(x1; x2)

2. Utility is given by U(x1; x2) = x1x2. Marginal utilities are MU1 = x2, and MU2 = x1. The price of x1 is \$1, the
price of x2 is \$2, and income is \$40. The price of x2 falls to \$1.

(c) What is the substitution effect of the price change? Illustrate on the graph.

(d) What is the actual optimal consumption choice after the price change? Illustrate on the graph and
label that choice C.

(e) What is the income effect of the price change? Illustrate on the graph.

# Utility is given by U(x1; x2)

2. Utility is given by U(x1; x2) = x1x2. Marginal utilities are MU1 = x2, and MU2 = x1. The price of x1 is \$1, the
price of x2 is \$2, and income is \$40. The price of x2 falls to \$1.

(a) Calculate the optimal consumption choice before the price change. Illustrate that choice on a graph.
Label that choice A.

(b) If, after the price change, income had changed so that the consumer could exactly afford his old
consumption bundle, what would his new income be? What would be the optimal consumption choice
with this new income? Illustrate that choice on the same graph. Label that choice B.

(c) What is the substitution effect of the price change? Illustrate on the graph.

(d) What is the actual optimal consumption choice after the price change? Illustrate on the graph and
label that choice C.

(e) What is the income effect of the price change? Illustrate on the graph.

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