Question

Regardless of your reasoning in the previous question, you find yourself back in school studying the historical economy of Liechtenstein. On the first day, you find yourself in the bookstore purchasing pens and notebooks for classes. You’ve decided that the marginal utility from the next notebook you pick up is 12 and the marginal utility from the next pen you get is 3. The notebooks are priced at $3 while the pens are only $0.50. The bundle you’re considering buying is on your budget constraint.

a. Is the bundle of notebooks and pens you’re considering buying optimal? Why or why not?

b. If the bundle is not optimal, does the optimal bundle contain more pens and fewer notebooks, or more notebooks and fewer pens?

This is the previous question just for context: Fascinated by what you’ve learned during your research, you begin to contemplate returning to college with the goal of becoming the world’s leading expert on Liechtensteinian ale production. Discuss the opportunity costs you’d face in such an endeavor.

Answer 1

(a) For optimality, we check if the ratio of MU/P for each product is equal or not. This is called the law of equimarginal utility. Here for notebooks, MU/P = 12/3 = 4. Similarly, for pens, MU/P=3/0.5 = 6.

We see here that -

(MU/P) for notebooks < (MU/P) for pens.

Thus for the bundle considered here, buying the same is not optimal.

(b) We have have two possibilities -

(i) Increase consumption of pens.

If we increase the consumption of pens and keep the same consumption of notebooks, the marginal utility of pens will fall such that slowly (MU/P) of pens will equal that of the notebooks.

(ii) Decrease consumption of notebooks.

If we decrease the consumption of notebooks and keep the same consumption of pens, the marginal utility of notebooks will increase such that slowly (MU/P) of notebooks will equal that of pens.

Thus, if we want to approach the equilibrium by changing consumption of both the products simultaneously, we must have more pens and fewer notebooks to get the optimal bundle.

Thank You and Best of Luck