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
MU MU/$
Books
MU MU/$
20 20/5 = 4 30 30/10 = 3

Since

then Kylie is not maximizing her utility. A person is

only maximizing her utility when the condition,

holds. In
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 $21 left over to spend on entertainment.
Find the optimal allocation of Franks entertainment budget by answering the
questions below.
No. of
Units
Trips to the Club per Week (C) Basketball Games per Week (B)
TU MU MU/$ 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).