Question
David and Jeppe are throwing a party. They have a budget of $30 to spend on...
David and Jeppe are throwing a party. They have a budget of $30 to spend on beer and snacks. The party guests’ welfare is a function of the quantity of beer and snacks of the form U(qB,qS) = qB^2/3 qS^1/3. Beer costs $2 per bottle and snacks cost $1 per pack.
1. What combination of beer and snacks do David and Jeppe buy? What is the level of utility of their guests? Clearly justify your answer using appropriate economic language.
Suppose the price of beer drops to $1 while the price of snacks increases to $4.
2. At these new prices, how much money must David and Jeppe spend on beer and snacks to make their guests as happy as you found in part 1.?
Suppose instead, the price of beer remained at $2 per bottle but the price of snacks increased to $8 per pack.
3. What is the compensating variation of this price increase? What is its economic interpretation?
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