Question

6) Consider the following information: Your income is equal to $ 12. You are to spend that income on goods x and good y. Good x costs $ 2 per unit and Good y costs $ 3 per unit. Show all work. This is a big question – worth 30 points.

a. Using your knowledge of utility and consumer behavior and the data below, show exactly how you would spend your income, on which goods and why.

Q MU x MU y 1 90 150 2 84 120 3 80 90 4 60 60

b. At what point do you reach equilibrium? Why is that considered equilibrium? (10)

Q	MU x	MUy
1	90	150
2	84	120
3	80	90
4	60	60

Answer 1

Req a:

The Consumer should spend the income among the product in such a way the MU per $ received from last unit consumed shall be equal. The Consumer shall start theconsumption of that product which highest MU per $ i.e. Unit of Product Y and spend $3 and next one unit of Product X as it gives second highest MU per $ after spending $2 (total spending has been $5). Next consumtion shall be Product X again as it gives higher MU then Product Y in second unit. Later on, the consumer shall spend the $ on third unit of X and second unit of Y (total spending will be $12 eqauls to income).

Req b.

The consumer will be in equilbrium when the last $ spent on each products yeild the same marginal utility.

Here with the limited income of $12, the consumer shall spend the income on 3 units of Product X and 2 units of Product Y, as it gives the same marginal utility per $ for both the products.

The MU per $ for each unit of consumption for both the products is as follows for the reference:

Q	Mux	Muy	Mux/Px	Muy/Py
1	90	150	45	50
2	84	120	42	40
3	80	90	40	30
4	60	60	30	20