Question

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1. 1.Masaba consumes two commodities, potato chips and beer. She maximizes her benefits according to the neoclassical approach. Suppose that the price of chips is $2 per bag, the price of beer is $4 per can, and her that her budget is $18. The table below provides information about her marginal valuation.

Number of bags of chips consumed	Marginal valuation of a bag of chips	Number beer cans consumed	Marginal valuation of beer
1	20	1	70
2	14	2	60
3	8	3	40
4	4	4	13
5	0	5	5

1. How much of each commodity will she consume? (Provide the formula and your calculations.) (1 points)
2. In a sentence or two provide the reasoning used by the neoclassical approach that would yield the answer in 3a. (1 point)

Answer 1

Solution:

The optimal commodity bundle to be consumed is where the marginal valuation per dollar price of one good equals the marginal valuation per dollar price of the other good. Also, the chosen bundle must be in the budget of the consumer.

Then, for the given table:

Marginal valuation of bag of chips/price of chips bag equals or is closest to Marginal valuation of beer/price of beer

So,marginal valuations of chips bags per dollar is: 1: 20/2 = 10 ; 2: 14/2 = 7; 3: 8/2 = 4; 4: 4/2 = 2; 0: 0/2 = 0

And for beer is: 1: 70/4= 17.5 ; 2: 60/4=15; 3: 40/4=10; 4 : 13/4 = 3.25; 5 : 5/4 = 1.25

So, clearly the marginal valuation per dollar for each good equals at 1 bag of chips and 3 beers, and the corresponding expense = 2*1 + 4*3 = 2 + 12 = $14

We still have 4 dollars left (18 - 14), so next either two more chips bags or 1 more beer could be taken. Two more chips bags will give a total additional utility of 14 + 8 = 22, while additional beer will give additional utility of 13. So in order to maximize utility, 2 more chips bags should be taken.

Finally, we have the final consumption bundle as: 3 bags of chips and 3 beers (total utility = 20+14+8+70+60+40 = 212).