Exhibit 21-3

-Refer to Exhibit 21-3.Assume that the price of oranges increases to $2,while the price of apples remains at $1,and Linda allocates $5 of the weekly food budget to purchasing apples and oranges.If Linda wants to maximize her utility,her new consumption bundle will consist of
A) 1 apple and 2 oranges.
B) 3 apples and 1 orange.
C) 5 apples and no oranges.
D) none of the above

Question

Exhibit 21-3
 
-Refer to Exhibit 21-3.Assume that the price of oranges increases to $2,while the price of apples remains at $1,and Linda allocates $5 of the weekly food budget to purchasing apples and oranges.If Linda wants to maximize her utility,her new consumption bundle will consist of
A) 1 apple and 2 oranges. 
B) 3 apples and 1 orange. 
C) 5 apples and no oranges. 
D) none of the above

Quizplus · Accepted Answer

To maximize utility, Linda should allocate her budget in such a way that the marginal utility per dollar spent on each good is equal. Thus, she should buy apples and oranges in the ratio of their prices to ensure that their marginal utilities per dollar spent are the same.

Initially, Linda was spending $2 on oranges and $3 on apples, which means she was buying 1 orange and 3 apples. At this consumption bundle, the marginal utility per dollar spent on oranges was MUo/Po = 8/2 = 4, and the marginal utility per dollar spent on apples was MUa/Pa = 12/3 = 4.

Now that the price of oranges has increased to $2, Linda can only afford to buy 2 oranges and 1 apple with her $5 budget. While consuming 2 oranges and 1 apple, the marginal utility per dollar spent on oranges is MUo/Po = 7/2 = 3.5, and the marginal utility per dollar spent on apples is MUa/Pa = 10/1 = 10.

This new consumption bundle does not have equal marginal utilities per dollar spent on each good, so it is not the optimal bundle. To find the optimal bundle, Linda should adjust the quantities of apples and oranges until the marginal utilities per dollar spent on each good are equal.

If Linda buys 3 apples and 1 orange for $5, she spends $3 on apples and $2 on oranges. At this consumption bundle, the marginal utility per dollar spent on oranges is MUo/Po = 6/2 = 3, and the marginal utility per dollar spent on apples is MUa/Pa = 9/3 = 3.

Thus, option B (3 apples and 1 orange) is the optimal consumption bundle for Linda given the new prices.

Exhibit 21-3 -Refer to Exhibit 21-3.Assume That the Price of Oranges Increases