Problem
Paula's preferences for goods x and y are given by the utility function, U = x 1/2 y 1/2. Her income is $160, and the price of good y is always $20. Suppose the price of x starts at $20 and then decreases to $5.
1. Calculate the income, substitution, and total effects of the price decrease on both goods. Show your work for full credit and round to 2 decimal places where appropriate.
2. Use a clearly labeled graph to illustrate the total, income, and substitution effects of the price decrease on Paula's consumption of goods x and y.