Question

Suppose that as a consumer you have $34 per month to spend on munchies—either pizzas, which cost $6 each, or Twinkies, which cost $4 each. Create a set of marginal utility tables for each product, like the ones below. Remember that they must show diminishing marginal utility as more of each product is consumed. Create the corresponding set of total utility tables for each product. Graph the budget constraint with Pizzas on the horizontal axis and Twinkies on the vertical axis. What are the intercepts? Can you express the budget constraint as an algebraic equation for a line? # of Pizzas 1 2 3 4 5 6 7 Marginal Utility Total Utility # of Twinkies 1 2 3 4 5 6 7 Marginal Utility Total Utility Should you purchase a Twinkie first or a Pizza first to get the “biggest bang for the buck”? How can you tell? What should you purchase second, third, etc. until you exhaust your budget? Confirm that the combination of Twinkies and Pizzas you end up with will maximize your total utility by computing the total utility from other points on the budget line and comparing them to what you chose.

Answer 1

e. To determine bang for buck we need to look at the tangency condition where MRS = P₁/P₂ (MRS = Marginal Rate of Substitution which is equal to MU₁/MU₂ and P_i = Price of the good). We have P₁/P₂ = 6/4 = 3/2 = MU₁/MU₂ ----> MU₁/6 = MU₂/4.This is the tangency condition where optimal amounts of the two goods are consumed. If the tangency condition does not hold, we can reach the optimal level by trading off consumption between the two goods based on which good gives the highest bang for buck. If MUi/Pi > MUj/Pj then we say that good i gives us the highest bang for buck. In our example, we have MU₁/6 ? MU₂/4. We do not yet know the relation between the two and hence cannot say which good gives the highest bang for buck without knowing the exact utility function. If MU₁/6 > MU₂/4 then good 1 (which is pizza) has the highest bang for buck and we must consume more of pizza. If MU₁/6 < MU₂/4 then Twinkies has the highest bang for buck and we must consume more of Twinkies.