Question

Q)

a) Suppose that your friend, Agnes, is just spent her money income by purchasing 8 units of A and 10 units of B at prices of $3 and $4 respectively. Before spending her money she told you that the marginal utility of A and B are equal for her, both are 30 utils each. Is Agnes a wise consumer? What would you suggest to her to become a wise consumer?

b)

You asked your friends, John and Jim to tell you how much EXTRA satisfaction they get by drinking wine and beer. Their answers are in the table below for the first four glasses of wine and beer respectively.

	John – MUbeer	John - MUwine	Jim-MUbeer	Jim-MUwine
1	20	30	15	7
2	18	25	14	5
3	15	20	13	3
4	10	15	11	1

Currently John has 2 glasses of beer and 2 glasses of wine in front of him. Jim has 1 glass of beer and 2 glasses of wine in front of him.

a. Will John be better off if he trades 1 glass of beer with Jim for a glass of wine? Will the trade be made?

b. Suppose John asks for the 2 glasses of wine that Jim has, and offers him a glass of beer instead. Will the trade be made?

Explain your answers.

Answer 1

(a)

Utility is maximized when (Marginal utility of A / Price of A) = (Marginal utility of B / Price of B).

In this case,

Marginal utility of A / Price of A = 30 / 3 = 10

Marginal utility of B / Price of B = 30 / 4 = 7.5

Since (Marginal utility of A / Price of A) > (Marginal utility of B / Price of B), Agnes is currently not maximize her utility.

Utility will be maximized if Agnes purchases less of good A and more of good B, until the ratios equalize.

NOTE: As per Answering Policy, 1st question is answered.