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: balance of payments accounts

Balance of payment is the sum of three separate accounts and must always be equal to 0 (given no statistical error): Current account: the net flow of funds exchanged for goods and services, and monetary gifts that flow in and out of a country. This is often used as an indicator for net export. Financial account: also known as the capital account, is the net flow of funds for investment in real assets (direct investments) or financial assets (stocks or bonds) into a nation. Official reserves: in order to balance the two accounts above, a country must have a reserve of foreign money. It measures the net effect of all money flows from the other accounts. If the current account is positive, it must be the case that the sum of the financial account and official reserves is negative. Current account (CA) components: Balance of trade in goods: spending by consumers and firms on imported and exported goods. Exported goods have a positive effect on the current account, whereas importe...

Macroeconomics: equilibrium in the AD/AS model

Real output and price level in the AD/AS model: The short run equilibrium in the AD/AS model, is when the intersection between the short run aggregate supply curve and the aggregate demand curve determines the level of output and price level. This short equilibrium output can be compared to the full-employment (i.e long run equilibrium) output by adding the long run aggregate supply curve in the graph. If the difference between the short run equilibrium output and full employment output is negative than we have a recessionary gap. This could be caused by a decrease in households' consumption, a fall in private investments, or a decrease in government spending. If the difference is positive, we have an inflationary gap, where the short run equilibrium output is bigger than its full employment output. This can be caused by an increase in households expenditures, expansionary fiscal policy, etc... If the gap is zero, this means that t...

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