Question

Cesar earns $60/week while attending UIC and consumes two goods: Beer (B) and Food (F). Beer costs $1/can and Food costs $3/lb. Cesar has the utility function U(B,F) = 2BF (with B in cans, F in lbs). This means his marginal utility from consuming beer is 2F and the marginal utility of consuming food is 2B.

Question 3: The price of food drops to $1/lb. How much food does Cesar now consume each week?

Question 5: What is the size of the income effect in Question 3. [HINT: the substitution effect plus the income effect equals the total change in food purchased after the price change]

Question 6: Revert back to the original scenario, where food costs $3/lb. Cesar’s parents now offer to give him an extra $90/week which Cesar can only spend only on food. Given this restriction, how many lbs of food will Cesar now buy?

Question 7: If Cesar’s parents did not restrict how he spent the money, Cesar would buy less food that he does with the restriction.

Question 8: Compared to when Cesar did not receive any money from his parents, how much more utility does he gain after receiving the restricted money in Question 6 (in units of utility)?

Question 9: If Cesar’s parents allow him to spend the money however he wishes, how much does his utility change compared to when they do restrict how he spends it? (in units of utility)

Answer 1