Suppose United Airlines is deciding on purchasing engines from General Electric (GE) and Rolls- Royce (RR) for its new Boeing 787 fleet with budget I=$2 billion. The airline company has utility function U (g, r) = g3r, where g are the engines produced by GE and r are the engines from RR. pg and pr are prices for each GE and RR engine respectively. The Marshallian demand functions
are g? = 3I and r? = I . 4pg 4pr
- Find the indirect utility function for United Airlines.
- Suppose pg = $25 million and pr = $20 million. What is United’s maximized utility? How many GE engines do they purchase?
- Now suppose the U.S. Department of Commerce is trying to promote American engine man- ufacturers. Thus United Airlines will be given a 10% subsidy on price when purchasing from GE, and levied a 15% tax on price when purchasing from RR.
- How does this policy affect United’s budget constraint? Write down the new budget and draw the old/new budget in the same graph.
- How many GE engines are purchased?
- What is the utility level of United Airlines with this policy?
- What is the total tax that United has to pay for purchasing the RR engines?
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