Suppose There Are Two Goods, Consumption C with Price P

question 73

Essay

Suppose there are two goods, consumption C with price p = 1 and leisure L with price w = 8. The endowments of the two goods are given by C₀ = 0 and L₀ = 2 4. The utility function is U(C,L)= logC + 2logL.
i)How much labour should be supplied and how much consumption should be chosen?
ii)Using all the information given above (except w = 8), show that the amount of labour supplied will be the same regardless of the wage rate. What must be true about income and substitution effects for this to occur?

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Definitions:

Aggregate Demand Curve

A graphical representation showing the relationship between the overall price level in an economy and the total demand for goods and services.

Potential Output

The maximum amount of goods and services an economy can produce when it is most efficiently utilizing its resources.

Expansionary Gap

A situation in an economy where actual gross domestic product exceeds the potential GDP, leading to inflationary pressures.

Natural Rate

The level of economic output at which the rate of inflation is stable, often related to the concept of the natural rate of unemployment where the labor market is in equilibrium.