Maxine eats salad and potatoes. Her preferences on salad (x) and potatoes (y) can be represented by the utility function U(x,y) = ln x + 5ln y where salad and potatoes both are measured in pounds. a) If the price of salad is Px per pound, the price of potatoes is Py per pound and she has
Maxine eats salad and potatoes. Her preferences on salad (x) and potatoes (y) can be represented by the utility function U(x,y) = ln x + 5ln y where salad and potatoes both are measured in pounds.
a) If the price of salad is Px per pound, the price of potatoes is Py per pound and she has $I to spend then find her demand
b) Suppose that Px = $1, Py = $1 and I = $60. Using your answer to (a) find her demands for salad and potatoes. Illustrate your answer in an indifference curve diagram. Include in your diagram an indifference curve through her best bundle.
The government would like to encourage people to eat salad. To do so they decide to tax the purchase of potatoes. The effect of the tax is to raise the price of potatoes to $1.25.
c) After the price increase what are Maxine’s new demands for salad and potatoes? Illustrate the effect of the tax in your diagram for part (b) and clearly label the substitution and income effects.
d) Did the tax on potatoes achieve the goal to raise the demand for salad? Use your substitution and income effects to explain your answer.
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