Question

Kawamura, a careful utility maximizer, consumes peanut butter and ice cream. Assume that both peanut butter and ice cream are normal goods and that diminishing marginal utility applies to both goods. Right after he achieves the utility-maximizing level of consumption of the two goods, the price of peanut butter falls. After he adjusts to this event, the marginal utility of peanut butter goes _____ and that of ice cream goes _____.

Answer 1

Answer:

The marginal utility of peanut butter goes down and that of ice cream goes up.

Explanation:

The substitution effect states that when the price of a product falls, it will lead to a rise in the quantity demanded of the product as buyers will buy more of the product that is now relatively cheaper.

And as more of a good is bought, its marginal utility falls. And as less of a product is bought, its marginal utility increases.

Based on the above explanation therefore, the marginal utility of peanut butter goes down and that of ice cream goes up after Kawamura adjusts to the event.

This is because as more of peanut butter is bought due to the fall in its price, its marginal utility falls. And as less of ice cream is bought as it is now relatively more expensive, its marginal utility increases.