Suppose the price of $A$ is $\$ 20$, the price of $B$ is $\$ 10$, and that the consumer is currently spending all available income. At the consumer's current consumption basket the marginal utility of $A$ is 8 and the marginal utility of $B$ is 2 .
A) The consumer is currently maximizing utility.
B) The consumer could increase utility by consuming more of good $A$ and less of good $B$.
C) The consumer could increase utility by consuming more of good $B$ and less of good $A$.
D) Nothing can be said about the consumer's utility because we do not know the consumer's income or utility function.

Question

Quizplus · Accepted Answer

The marginal utility per dollar of $A$ is 0.4 ($8/20$) and the marginal utility per dollar of $B$ is 0.2 ($2/10$). Since the marginal utility per dollar of $A$ is greater than the marginal utility per dollar of $B$, the consumer should reallocate spending towards good $A$ and away from good $B$ to increase utility, according to the principle of diminishing marginal utility. The consumer is currently maximizing utility because the marginal utility per dollar spent on each good is equal (MUa/Pa = 8/20 = 0.4 and MUb/Pb = 2/10 = 0.2), indicating that there is no other affordable consumption bundle that would allow the consumer to increase overall utility. However, since the marginal utility of good A is greater than the marginal utility of good B, the consumer could increase utility by consuming more of good A and less of good B, until the marginal utility per dollar spent on both goods is equal again. This would increase overall utility since the consumer would be obtaining more utility per dollar spent. Therefore, option B is correct.

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