Author Question: During droughts, cities often impose water use restrictions on consumers. Suppose a representative ... (Read 51 times)

berenicecastro · **on:** Jul 1, 2018

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.

Question 2

Market structure depends upon

A) the ease of entry and exit.
B) the ability of firms to differentiate their goods and services.
C) the number of firms in the market.
D) All of the above.

Zebsrer · **Reply #1 on:** Jul 1, 2018

Answer to Question 1

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.

Answer to Question 2

D