Herbie consumes two goods and his utility function is U(x₁, x₂) = x³₁x⁴₂. The price of good 2 does not change and his income does not change, but the price of good 1 decreases.

Question

Quizplus · Accepted Answer

According to the utility function, both goods are normal goods, meaning that as income increases, the demand for both goods increase. Since the income does not change, the income effect is zero. The substitution effect dominates, which means that the decrease in the price of good 1 will make it relatively cheaper compared to good 2, and the consumer will substitute good 2 with good 1. Therefore, the demand for good 1 will increase, and the demand for good 2 will decrease.

Herbie Consumes Two Goods and His Utility Function Is U(x1

Herbie Consumes Two Goods and His Utility Function Is U(x₁