Question

Suppose hamburgers are on the horizontal axis and root beer on the vertical axis. Your budget allowance is $10 and the price of hamburgers is $4 each and root beer $2 each. If at your present consumption of hamburger and root beer your marginal rate of substitution of hamburger for root beer is 4, to maximize utility you should __________.

Answer 1

Answer:

Suppose hamburgers are on the horizontal axis and root beer on the vertical axis. Your budget allowance is $10 and the price of hamburgers is $4 each and root beer $2 each. If at your present consumption of hamburger and root beer your marginal rate of substitution of hamburger for root beer is 4, to maximize utility you should consume more hamburger and fewer root beers.

Explanation:

At optimal point, MRS=Price of hamburger/Price of root beer.

Thus, slope of budget line=price of hamburger/ price of root beer= 4/2= 2

MRS=4

Therefore, slope of budget line < MRS which is not an optimal bundle.

However, we cannot change the prices, we can only change MRS.

In order to reduce the MRS, we have to consume more hamburgers. Reason being that, the law of diminishing marginal utility states that as we consume more of a good the utility derived from the additional unit reduces as the  rate of consuming a good increases.

So we need to consume more hamburgers so as to reduce the utility. Thus, Thus, the marginal utility, MU  of hamburger falls

Similarly,we will have to  reduce the consumption of beer so as  to increase the utility.Thus, MU of beer rises.

As MU hamburger increases/MU root beer decreases, MRS increases until MRS = slope pf Budget line.