Emma’s preferences can be represented by U(x,y) = min {x,y}, where x is pairs of earrings and y is necklaces. She faces prices (px,py) = (2,1) and her income is 12.
a. What is Emma’s optimal bundle of earrings and necklaces?
b. Suppose the price of earrings rises to $3 and Emma’s income stays the same. What is her new optimal bundle of earrings and necklaces?
c. Calculate the compensating variation.
d. Calculate the equivalent variation.
e. Why is the compensating variation larger than the equivalent variation?