Skip to main content

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:

Let's use the information from the table above, 

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
Labels:

Comments

Post a Comment

Popular posts from this blog

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 ...
Post a Comment
Read more

Exercise: maximizing profit

Assume that you are the owner of a small business that produces T-shirts. Your the total revenue for your business can be modeled by the following equation: and your total cost corresponds to this function: Find the point at which your firm maximizes its profit. Then, find how much profit the firm if able to earn at that point. Using the total cost and total revenue functions we can set up the profit function: Then, realize that if you want to find the maximum profit, take the derivative of the function and set it up equal to zero, and solve for Q. This is equivalent of taking the derivative of the total cost and total revenue functions and setting them equal to each other. In this problem, I chose the latter option as it was explained in the previous lessons. Notice that profit is often denoted by a capital pi.  We are assuming that the TR>TC for some positive value, you can check for yourself. However, if we did not know that, we would first take the first ...
Post a Comment
Read more

A short interlude...

Hello all, it's been quite some time since I have made any major announcements since the creation of this blog about a year and a half ago. I am currently in graduate school and will soon take a portion of my comprehensive examination (i.e exams in Micro, Macro, and Metrics that will allow me to continue my studies in my graduate program), wish me luck! Thus, I will not be able to post consistently until at least mid-June. The roadmap is as such, if I pass, I will start introductory lessons in Econometrics and Statistics (if not, then I'll have to study until I can retake the comps in August). I hope that once I am done, I will be able to add more advance materials to the blog, such as general equilibrium, indirect utility functions, and game theory/mechanism design for Micro. The Solow, Ramsey, RBC, New Keynesian models, permanent income hypothesis (PIH) and more for Macro. By the way I think I still need to add notes on the IS-LM curves, so I will do that before jumping to t...
Post a Comment
Read more