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What is the rule relating the ratio of marginal utility to prices of two goods at the optimal choice? Explain why, if this rule does not hold, the choice cannot be utility-maximizing.

Short Answer

Expert verified

Marginal utility of two goods change with quantities consumed.

Step by step solution

01

Step 1. Introduction:

The general rule can also be expressed as the ratio of the prices of the two commodities must be equal to the ratio of the marginal utilities. It is written as:

P1P2=MU1MU2

02

Step 2. Explanation:

At the utility-maximizing point, dividing the price of good 1 by the price of good 2 equals the marginal utility of good 1 divided by the marginal utility of good 2. Along with the budget constraint, the total price of the two goods stays unchanged, so the price ratio does not alter. The marginal utility of the two commodities, however, varies with the quantity consumed. The utility ratio between two goods should be one if optimal choice is made. Alternatively, additional utility could be gained by substituting one good for the other. The problem of determining consumer equilibrium, or the combination of goods and services that maximizes an individual's total utility, boils down to weighing the trade-offs between one affordable combination and all other affordable combinations.

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Most popular questions from this chapter

Jeremy is deeply in love with Jasmine. Jasmine lives where cell phone coverage is poor, so he can either call her on the land-line phone for five cents per minute or he can drive to see her, at a round-trip cost of \(2 in gasoline money. He has a total of \)10 per week to spend on staying in touch. To make his preferred choice, Jeremy uses a handy utilimometer that measures his total utility from personal visits and from phone minutes. Using the values in Table 6.6, figure out the points on Jeremy鈥檚 consumption choice budget constraint (it may be helpful to do a sketch) and identify his utility-maximizing point.

Round TripsTotal UtilityPhone MinutesTotal Utility
0000
18020200
215040380
321060540
426080680
5300100800
6330120900
7200140980
81801601040
91601801080
101402001100

As a college student you work at a part-time job, but your parents also send you a monthly 鈥渁llowance.鈥 Suppose one month your parents forgot to send the check. Show graphically how your budget constraint is affected. Assuming you only buy normal goods, what would happen to your purchases of goods?

If people do not have a complete mental picture of total utility for every level of consumption, how can they find their utility-maximizing consumption choice?

If a 10% decrease in the price of one product that you buy causes an 8% increase in quantity demanded of that product, will another 10% decrease in the price cause another 8% increase (no more and no less) in quantity demanded?

Take Jeremy鈥檚 total utility information in Exercise 6.1, and use the marginal utility approach to confirm the choice of phone minutes and round trips that maximize Jeremy鈥檚 utility.

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