Question

A Californian student consumes Internet services (I) and books (B). Her preferences are represented by a Cobb-Douglas utility function of the type: U(I,B) = I .5B.5. Initially Y = 100, PI = PB = 1. Lately, however, because of the electricity shortage, the price of the Internet services has increased to 2. The government has decided to give a transfer to the student so that she can recover her initial welfare. In order to determine the transfer the government has hired three consultants who have made the following suggestions:

Consultant A: The transfer should allow the student to buy her initial bundle.

Consultant B: The transfer should allow the student to get her initial level of utility.

Consultant C: The government should give her a transfer of 20.

a. Using the expenditure function, find the amount of the transfer implied by consultant A.

b. Find the amount of the transfer implied by consultant B.

c. Determine whether the consumer is better or worse off from Consultant Cʹs suggestion than before the price increases.

Answer 1