Question

Toby's current marginal utility from consuming peanuts is 100 utils per ounce and his marginal utility from consuming cashews is 100 utils per ounce. If peanuts cost $.10 per ounce and cashews cost $.25 per ounce, is Toby maximizing his total utility from the kinds of nuts? At the current level of peanut consumption, Toby receive___utils per dollar At the current level of cashews consumption, Toby receives __Utils per dollar Therefore, Toby ----maximizing his total utility because MU plPp is--MUdPc.

Answer 1

Spending should be allocated across goods so that the marginal utility per dollar (the ratio) is same for each good

MUx / Px = MUy/ Py

If Rational Spending Rule is not satisfied, we can always reallocated the goods

Rational Spending Rule:

Increase (decrease) the consumption of one good, will decrease

(increase) the MU per dollar of that good.

(Marginal Utility is a decreasing function with consumption)

The adjustment process continues until there is no way to increase

the utility by moving the last dollar from one good to the other, i.e.,

when Rational Spending Rule is satisfied.

• Spending a dollar more on good X, the MU per dollar from consuming X falls
• Spending a dollar less on good Y, the MU per dollar from consuming Y rises

MUx / Px = MUy/ Py

Check the marginal utility per dollar spent on the two goods.

The MU per dollar from consuming peanuts is:

100utils per ounce/$0.10 per ounce

= 1000utils per dollar from his last dollar spent on peanuts

•

The MU per dollar from consuming cashews is:

100utils per ounce/$0.25 per ounce

= 400utils per dollar from his last dollar spent on cashews

MU/$ on Peanuts: 1000utils per dollar

MU/$ on Cashews: 400utils per dollar

Toby is not maximizing his total utility from the kinds of nuts.

In order to maximizes his total utility, he should rearrange his

consumption.