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Chapter 10: Problem 3

What is meant by a consumer's budget constraint? What is the rule of equal marginal utility per dollar spent?

Short Answer

Expert verified
A consumer's budget constraint shows all combinations of goods they can afford with their given income. The rule of equal marginal utility per dollar spent means a consumer's spending is optimized when the ratio of incremental satisfaction to price is equal across all goods.

Step by step solution

01

Defining a Consumer's Budget Constraint

A consumer's budget constraint illustrates what they can afford given their income and the prices of goods and services they plan to purchase. It's a boundary illustrating their consumption opportunities. The formula for a budget constraint is \(P_x X + P_y Y = I\), where \(P_x\) and \(P_y\) are the prices of goods X and Y respectively, and I is the consumer's income.
02

Explaining the Rule of Equal Marginal Utility per Dollar Spent

This rule suggests a strategy for consumers to maximize their overall utility, given their budget. It suggests that a consumer reaches the highest level of utility when the ratio of the marginal utility (which is the satisfaction gained from consuming an additional unit of the good) to its price is the same for all goods. In other words, the spending should be allocated across goods in such a way that the consumer obtains the same amount of extra satisfaction per dollar spent on each.
03

Mathematical representation of the rule of equal marginal utility per dollar spent

The mathematical rule is given as: \(MU_x / P_x = MU_y / P_y\), where \(MU_x\) and \(MU_y\) are the marginal utilities of goods X and Y respectively, and \(P_x\) and \(P_y\) are their prices. This equation signifies that the consumer should adjust their consumption until the ratio of the marginal utility and price of each good consumed equals each other.

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Most popular questions from this chapter

Define behavioral economics. What are the three common mistakes that consumers often make? Give an example of each mistake.

(Related to the Apply the Concept on page 346) Baseball writer Rob Neyer described attending a Red Sox game at Fenway Park in Boston and having a seat in the sun on a hot, humid day: "Granted, I could have moved under the overhang and enjoyed today's contest from a nice, cool, shady seat. But when you paid forty-five dollars for a ticket in the fourth row, it's tough to move back to the twenty-fourth [row]." Briefly evaluate Neyer's reasoning.

In which of the following situations are social influences on consumer decision making likely to be greater: choosing a restaurant for dinner or choosing which brand of toothpaste to buy? Briefly explain.

Does using rules of thumb increase or decrease the likelihood of a consumer making an optimal choice? Briefly explain.

What does it mean to be economically rational?
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