Question:
Max has a utility function U =√ x1x2 where x1 is liters of ice-cream and x2 is boxes of strawberries. The marginal utility of a liter if ice-cream is MU1=0.5 √x2/ x1 and the marginal utility of a box of strawberries is MU2 =0.5 √x1 /x2. The prices of x1 and x2 are both $2 and Max has a budget of $80.
(a) How much of each good will Max demand?
(b) A fat-tax of $2 per liter is placed on ice-cream so that it now costs Max $4 per liter. Everything else remains the same. How much of each good does Max now consume? How much tax does he pay?
(c) Now suppose that, instead of imposing a $2 tax on ice-cream, the government imposes a $20 income tax, reducing Max's budget to $60. Would Max prefer the $2 tax on ice-cream or the $20 reduction is his budget?
Additional Information:
The question is about economics and it discuss how much of each good will Max demand? A fat-tax of $2 per liter is placed on ice-cream so that it now costs Max $4 per liter. Everything else remains the same. How much of each good does Max now consume? How much tax does he pay?