Carmen Sandiego receives utility from days spent traveling domestically (D) and days spent traveling internationally (F) as given by the utility function U(D;F) = D^1/2 F^1/2 . The price of a day of traveling domestically is Pd = $240 and in a foreign country Pf = $320. Carmen Sandiego's annual budget is $9600.
- Find Carmen Sandiego's utility by maximizing the choice of domestic and foreign travel. Find her utility consuming that bundle.
- Suppose the price of domestic travel increases to PD = $300 per day. Find the new optimal bundle at this price as a function of her budget for traveling I:
- Find the income needed for Carmen Sandiego to reach the same utility as before the price change.
- Compute the quantities demanded with the new prices and the new income you found in part c)
- Compute the quantities demanded with the new prices and the original income.
- Decompose the changes in the quantity of D due to the income and substitution effects; illustrate with a graph. Give definitions of what the income and substitution effects mean.