Holly consumes only goods X and Y.Her income is $500 and her utility function is U(x, y)= max{x, y}, where x is the number of units of X she consumes and y is the number of units of Y she consumes.The price of good Y is 1.The price of good X used to be 1/3 but is now 2.The equivalent variation of this price change for Holly is

Question

Quizplus · Accepted Answer

The equivalent variation is the amount of money needed to compensate Holly for the price increase. Initially, she could buy 1500 units of X with her $500 income (since the price was 1/3). Now, with the price at 2, she can only buy 250 units. To maintain her utility, she needs enough money to buy 1500 units at the new price, which would cost $3000. The equivalent variation is $3000 - $500 = $2500. However, since she only needs to maintain her utility level, she needs to be able to buy 500 units of Y (since U(x, y) = max{x, y}), which costs $500. Therefore, the equivalent variation is $333.33.

Holly Consumes Only Goods X and Y