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MrsAngelD MrsAngelD
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Posts: 322
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6 years ago
During droughts, cities often impose water use restrictions on consumers. Suppose a representative consumer has preferences for Water (W) and other goods (X) given by the utility function:
   U(W,X) = WX.
Suppose the price of other goods is $1 and the price of water is initially 50¢. The consumer has a budget of $50/week.
a.   How much water will the consumer purchase each week?
b.   Suppose the government imposes a quota on water use of 50 units/week. Show that the quota reduces the representative consumer's utility.
c.   By how much does the quota harm the representative consumer? Specifically, compute the equivalent variation of the quota.
Textbook 
Microeconomics: Theory and Applications with Calculus

Microeconomics: Theory and Applications with Calculus


Edition: 4th
Author:
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Replies
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6 years ago
a.   The consumer will choose 100 units of water per week.
b.   Since the consumer can no longer consumer the optimal bundle from before, she will choose a bundle of 50 units of water (costing $25) and spend $75 on other goods. Her utility before was U(100,50)=5000 and now is U(50,75) = 3750. She is indeed worse off from the quota.
c.   We wish to find the amount of income which will lead to a utility of 3750 without a quota. The MRS = MRT condition is X/W = .5/1, or 2X = W. Plugging into the utility function, 2X2 = 3750 or X = 43.3. So Y = 86.6. The Expenditure for this bundle of goods is $86.6. Thus the EV is 86.6 - 100 = -13.4.
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