Suppose that Julia receives a $20 gift card for the local coffee shop, where she only buys lattes and muffins. If the price of a latte is $4 and the price of a muffin is $2, then we can conclude that Julia
A) should only buy muffins.
B) should only buy lattes.
C) can buy 5 lattes or 10 muffins if she chooses to buy only one of the two goods.
D) can buy 5 lattes and 10 muffins with her $20 gift card.

Question

Quizplus · Accepted Answer

Since Julia has a fixed budget of $20 and she can buy two different goods with different prices, the optimal choice is to find the combination that maximizes her utility. The marginal utility per dollar spent on lattes is 1/4 = 0.25, while the marginal utility per dollar spent on muffins is 1/2 = 0.5. Therefore, Julia should choose muffins until the marginal utility per dollar spent on muffins equals the marginal utility per dollar spent on lattes. This happens when she has spent $12 on muffins and has bought 6 muffins. At that point, her remaining budget is $8, which can buy her 2 lattes. Therefore, she can buy 5 lattes and 6 muffins with her $20 gift card.

Suppose That Julia Receives a $20 Gift Card for the Local