Question

Assume diminishing marginal utility in good X and Y.

Leigh is currently consuming 4 units of X and 4 units of Y.

At these levels of consumption, the marginal utility of a unit of X is 10 utils and the marginal utility of a unit of Y is 10 utils.

The price of good X is $1 and the price of good Y is $2.

According to our consumer equilibrium condition, which of the following is true?

Question 3 options:

	Leigh is not maximizing her utility. She should buy more X and less Y
	Leigh is maximizing her utility
	Leigh is not maximizing her utility. She should buy less X and more Y

Answer 1

In case of two goods, Consumer will achieve equilibrium at a point where:

Marginal utility of X/Price of X = Marginal utility of Y/Price of Y

There can be two situations if consumer is not in equilibrium:

• If Marginal utility of X/Price of X > Marginal utility of Y/Price of Y, it means that utility from an extra unit of X is greater than the utility from extra unit of Y. This will cause person to buy more of X and due to law of diminishing marginal utility the marginal utility from X will decrease and this will continue until equilibrium achieved again.
• If Marginal utility of X/Price of X < Marginal utility of Y/Price of Y, it means that utility from an extra unit of Y is greater than the utility from extra unit of X. This will cause person to buy more of Y and due to law of diminishing marginal utility the marginal utility from Y will decrease and this will continue until equilibrium achieved again.

Here in this question:

Marginal utility of X/Price of X =10/1= 10

Marginal utility of Y/Price of Y = 10/2= 5

Marginal utility of X/Price of X > Marginal utility of Y/Price of Y. Consumer is not in equilibrium and this will cause person to buy more of X.

Correct answer is:

Leigh is not maximizing her utility. She should buy more X and less Y