QUESTION 24 The optimal amount of x1.x2. P1,P2 and are given by the following Th

Question

QUESTION 24 The optimal amount of x1.x2. P1,P2 and are given by the following The original prices are: P1-27 P2 35 The original income is: 1-5,560 The new price of P1 is the following: P1'-88 Assume that the price of x1 has changed from P1 to P1. What is the substitution effect? QUESTION 25 Belfast Company produces bicycles using labor (L) and capital (K). Its production function is given where Q is the output of bicycles. The prices of labor (PL), capital (PK), bicycle (P) and the cost (C) are the following: PL=1, PK-23, P-65 and C-3808 What is the amount of maximized profits?

Explanation / Answer

Substitution effect

?xs = demand for x1 (at new price P1' and new income I') – demand for x (at old price P1 and old income I')

New income = The change made in old income to make old bundle purchasable at new price.

137.284*88 = 12081 . Hence new income is $12081

Substitution effect

?xs =  (4*12081)/(6*88) -  (4*5560)/(6*27)  = -45.76

Hence the substitution effect is -45.76

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