Suppose Esmerelda consumes only burlap and doorknobs. Given her income and the o

Question

Suppose Esmerelda consumes only burlap and doorknobs. Given her income and the original prices, pB = $25.99 and pD = $313, she consumed 11 doorknobs and 14 square feet of burlap. the price of doorknobs decreases dramatically due to advances in manufacturing techniques such that now pD = $15. Now she consumes 43 doorknobs and 12 square feet of burlap.

1) Define gross complement

2) Define gross substitute

3) Are burlap and doorknobs gross substitutes or gross complements for Esmerelda?

4) Suppose Ivan has preferences over burlap and doorknobs given by U(XB,XD) = 15XB2 + 36XD2 + 16. Are burlap and doorknobs gross substitutes or gross complements for Ivan?

5) Are doorknobs normal goods for Ivan?

6) Are Ivan’s preferences homothetic?

Provide explanation please Thank you

Explanation / Answer

1) Gross complement are those goods which are used together and if the price of one good (say Good X) increases, the demand for other good (say Good Y) decreases. Example- car and petrol.

2) Gross subsitute are those goods which can be used in place of each other and if the price of one good(say Good X) increases, the demand for the other good( say Good Y) increases. Example - pepsi and coca-cola.

3) Burlap and doorknobs are substitute goods for Esmerelda because when price of doorknobs decreases from $313 to $15, the demand for burlap decreases from 14 sq feet to 12 sq feet.

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