Suppose the only two goods you care about in the world are French wine (x) and Cuban cigars (y) and your utility function is given by u(x,y)=xy.You have no income, and the only thing in the world you possess is a large box you have just inherited from your rich uncle who passed away last week (of liver and lung cancer.) You open the box, and much to your liking, you find it contains 9 bottles of fine French wine and 3 boxes of exquisite Cuban cigars.Currently, the wine sells for $1 per bottle, and the cigars sell for $9 per box.Just as you receive the inheritance, you read the headline: "President Lifts Embargo - Price of Cuban Cigars Falls to $4 per Box!"
a.Determine the income (or wealth) and substitution effects of a decrease of the price of cigars from 9 to 4.(Assume fractions of bottles and cigars can be bought.)
b.Are cigars a normal or inferior good for you?
c.How much would you have been willing to pay the President in order not to lift the embargo?

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The Answer of Suppose the only two goods you care about in the world are French wine (x) and Cuban cigars (y) and your utility function is given by u(x,y)=xy.You have no income, and the only thing in the world you possess is a large box you have just inherited from your rich uncle who passed away last week (of liver and lung cancer.) You open the box, and much to your liking, you find it contains 9 bottles of fine French wine and 3 boxes of exquisite Cuban cigars.Currently, the wine sells for $1 per bottle, and the cigars sell for $9 per box.Just as you receive the inheritance, you read the headline: "President Lifts Embargo - Price of Cuban Cigars Falls to $4 per Box!"
a.Determine the income (or wealth) and substitution effects of a decrease of the price of cigars from 9 to 4.(Assume fractions of bottles and cigars can be bought.)
b.Are cigars a normal or inferior good for you?
c.How much would you have been willing to pay the President in order not to lift the embargo?

Suppose the Only Two Goods You Care About in the World