Eric receives utility from days spent traveling on vacation domestically (D) and days spent traveling in a foreign country (F) as given by the utility U(D, F) = DF. The price of a day spent traveling domestically is $160 and in a foreign country $200. Eric’s annual budget for traveling is $8,000
1) Find Eric’s utility maximizing choice of days traveling domestically and in a foreign country. Find also his utility level from consuming that bundle.
2) Suppose that the price of domestic traveling increases to $250 per day. Calling his budget for traveling x, (suppose by now that it is unknown) find the demand for D and F under the new prices as a function of x.
3) Find the income necessary to make Eric reach the same utility level as before the price change.
4) Compute the quantities demanded with the new prices and the income you found in section c.
5) Compute the quantities demanded with the new prices and the original income.
6) Using your previous answers tell us what is the total change in quantity of D due to the price increase in PD that the consumer experiences and what part of that change is due to income or substitution effects. Give definitions of what income and substitution effects mean.
7) Draw a graph showing the income and substitution affects you found.