Exercise: maximizing utility

You are given a table containing the quantities, price, and marginal utilities of two goods, fudge and coffee, which consumer A purchases.

Table:	Fudge	Coffee
Quantity of purchase	11 pounds	6 pounds
Price per pound	$3	$3
Marginal utility of last pound	13	24

If consumer A spends all of their income on these two goods, what should consumer A do in order to maximize their utility? (hint: remember the utility maximizing rule)

since we know that the utility is maximized when:

$\frac{MU_F}{P_F}=\frac{MU_C}{P_C}$

Let's use the information from the table above,

$\frac{13}{\$3}< \frac{24}{\$3}$

we can clearly see that the marginal utility for coffee is greater than that of fudge. Utility is subjected to the law of diminishing marginal utility; marginal utility (MU) diminishes as consumers buy more. Thus, in order to maximize their utility, consumer A needs to buy more coffee and less fudge up until the ratio of the MU of coffee over its price is equal to the ratio of the MU of fudge over the price of the latter.

Source: example inspired from the 2008 AP Microeconomics exam found on p.74 of AP Microeconomics Crash Course. Research & Education Association (2014), by Mayer. David

Comments

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP). Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...

Macroeconomics: Fiscal Policy and short run effects of fiscal and monetary policies

Fiscal Policy: government spending and taxation, aimed at expending or contracting the level of macroeconomic activity in a nation. A tax increase (decrease) will raise (lower) households' disposable income, leading to more (less) consumption. Furthermore, firms will increase (decrease) the number of investment as they get to keep a larger (smaller) share of their profits. An increase (decrease) in government spending affects the variable G that defines the aggregate demand. Government spending also leads to a change in household income, affecting the level of consumption. Tax multiplier: just like any multiplier so far, it is just the sum of a converging geometric series: Say the MPC is equal to 70%, then it must be the case that the MPS is 30%. Thus, the tax multiplier, t, is equal to about -2.32. In other words, for every dollar that goes to tax revenue, total spending decreases by about 2.32 dollars. Note that a tax decrease would be negative, and thus have a positi...

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run. If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...

Economics and Statistics

Search This Blog