ECONONE Homework #2 and Reviewer Utility Maximization. Show all solutions.

Please highlight (encircle or put a box around) all final answers. 1. Kylie spends her income of $150 per week on two goods: movies (which cost $5 each) and books (which cost $10 each). At her current level of consumption, the marginal utility from the last movie consumed is 20 and the marginal utility from the last book consumed is 30. Is Kylie maximizing her utility? Why or why not? If not, what should Kylie do to achieve a higher level of utility? Movies Since MU 20 MU/$ 20/5 = 4 Books MU 30 MU/$ 30/10 = 3

then Kylie is not maximizing her utility. A person is holds. In

only maximizing her utility when the condition,

order to maximize her utility, Kylie should spend more of her income on movies. This would decrease the marginal utility of the additional goods consumed therefore lowering the marginal utility per dollar. Since less of her money is being allotted to books, the marginal utility increases along with the marginal utility per dollar. Kylie should continue doing this until the marginal utility per dollar is the same for both movies and books 2. Matilda receives $8 per day to purchase lunch. She spends lunch on bagels (which cost $1 each) and soda (which costs $1 per bottle). Draw Matildas budget constraint. Put the bagel on the y-axis and the soda on the x-axis. If the price of the bagel falls to $0.75, what will happen to Matildas budget constraint? Illustrate in the same graph.

If the price of the bagel falls to $0.75 the budge constraint will shift upwards, increasing the opportunities of buying both goods.

In a separate graph, illustrate what will happen to Matildas budget line if her allowance decreases to $5 per day. Assume that the price of the bagel remains to $1 each and the price of soda is $1 each before and after Matildas allowance declined.

If Matildas budget decreases to $5 per day then her budget line draws nearer to (0, 0) making her opportunities to buy both goods less.

3. Frank is splitting his time between two activities, basketball and going to the club, per week to maximize total utility. Suppose that it costs $3 to get into the club and $6 to a basketball game. Furthermore, after paying the rent and taking care of other expenses, Frank has only $21 left over to spend on entertainment. Find the optimal allocation of Franks entertainment budget by answering the questions below. Trips to the Club per Week (C) Basketball Games per Week (B) No. of Units TU MU MU/$ TU MU MU/$ 1 12 12 4 21 21 3.5 2 22 10 3.33 33 12 2 3 28 6 2 42 9 1.5 4 32 4 1.33 48 6 1 5 34 2 0.66 51 3 0.5 6 34 0 0 51 0 0 4.1 If the initial allocation of Franks entertainment budget is two trips to the club (2C) and three basketball games (3B) per week, is he maximizing his utility? Why or why not? Frank is not maximizing his utility because and in order to maximize his utility . 4.2 What combination of trips to the club and basketball games per week would maximize Franks utility given his budget constraint? What is Franks total utility given this combination?

Given Franks entertainment budget of $21, 3 trips to the club and 2 basketball games would satisfy both his budget and his utility. Given this combination, Franks total utility would reach 61 utils. This combination would give him the most satisfaction given his budget constraint. 4.3 Show graphically how Franks opportunity set would change if real income was to increase to $42. In one graph, draw the opportunity sets for real income equal to $21 and real income equal to $42. Put trips to the club on the x-axis and basketball games on the y-axis. Next, draw the indifference curve, which contains the utility maximizing combination of trips to the club and basketball games when real income is equal to $21 on the same graph. Label all axes, curves and coordinates. At real income equal to $42, would the initial optimal point in letter b still hold? Why or why not?

At real income of $42, the optimal point in letter b will still hold. This is because the next optimal point would be 6 trips to the club and 6 basketball game and at $42, Frank still cant afford it.

4. Use Figure 1 to determine the answers to the succeeding questions. 4.1 At which indifference curve is the consumers total utility the highest in consuming shakes and pizzas achieved? Does this indifference curve contain the bundle of good that would maximize the consumers utility in consuming shakes and pizza? Justify your answer. The indifference curve farthest from the origin (the one that gives 125 utils of satisfaction) is where the highest total utility of consuming shakes and pizzas achieved. This would not maximize the consumers utility in consuming shakes and pizza because it is not within his budget constraint.

4.2 If the goal is to maximize utility given a particular budget, would the consumer choose to consume the combination of shakes and pizza represented by point D? Why or why not? The consumer would not choose the combination represented by point D, because it would not maximize his satisfaction. He can afford 100 utils of satisfaction, so naturally he would not settle for anything less, especially when his goal is to maximize his utility. 4.3 If the goal is to maximize utility given a particular budget, would the consumer choose to consume the combination of shakes and pizza represented by point E? Why or why not? The consumer would not choose to consume the combination of shakes and pizza represented by point E because he cannot afford it. It is simply not within his budget constraint. 4.4 Points C and D are on the same indifference curve. What does this tell us about the utility generated at these points? Explain. An indifference curve is defined as a locus of points that shows different combinations of consumption of several commodities that will give the consumer the same level of satisfaction or utility (Tullao, 2009). This only means that points C and D gives the same level of satisfaction, specifically 75 utils. 4.5 Identify the utility maximizing bundle of goods for this consumer. Theoretically, why is this said to be the combination of shakes and pizzas that would yield the highest utility for the consumer given a specific budget? Point A is the utility maximizing bundle of goods for this consumer. It is said to be the combination of shakes and pizzas that would yield the highest utility for the consumer given a specific budget because it is within the budget constraint. It is also the point within the constraint that would give the consumer the highest satisfaction (100 utils).