Compensating variation (CV) is the amount of money that a consumer would need to be given in order to be as well off as before the price change. Equivalent variation (EV) is the amount of money that a consumer would need to be given in order to be as well off as if the price change had not occurred.
Compensating variation = 100 - (2^0.5/2^0.5) = 100 - 2 = 98
Equivalent variation = 100 - (2^0.5/1) = 100 - 2^0.5 = 97.32
Suppose that consumer has utility function U(X1, X2)=X½,X½. He originally face price (1,1) and has income 100. Then the price of good1 increase to 2.
a)Explain and find the compensating and equivalent variation?
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