Chapter 10, Problem 6P

To determine

To answer:

The questions based on the given situations

Concept Introduction:

Marginal utility per dollar: This is calculated by dividing marginal utility of a good by the price of the good

Marginal utility: This is the additional benefit or satisfaction derived from the consumption of an additional unit of a commodity or service.

Utility: This is the benefit or satisfaction derived from the consumption of a good or service

Explanation of Solution

1. Cal’s consumption bundle consists of the following

Nikes, sunglasses

Nike, sunglasses

Nike, sunglasses



The above diagram shows the marginal utilities per dollar of Nikes and Sunglasses, the intersection between these points shows the optimal choice for Cal, the optimal point is denoted by the capital letter ‘E’. The quantity of Nikes is measured from left to right and the quantity of sunglasses measured from right to left on the horizontal axis. In the vertical axis the marginal utilities per dollar of both Nikes and Sunglasses are measured. Of the entire possible consumption bundle Cal could consume bundle that contains Nike and sunglasses. It is considered as the optimal consumption bundle, in this bundle the marginal utility per dollar spent on Nikes and marginal utility per dollar spent on Sunglasses are equal so it is the optimum consumption bundle.

2. The available consumption bundle for Cal is the following. These bundles lies on the budget line of Cal’s

Nikes, sunglasses

Nikes, sunglasses

Nikes, sunglasses

Nikes, sunglasses

`4 Nikes, sunglasses

Quantity of Nikes	Utility from Nikes	Marginal utility of Nikes	Marginal utility per dollar	Quantity of sunglasses	Utility of sunglasses	Marginal utility of sunglasses	Marginal utility per dollar
		-	-			-	-

The above table shows the marginal utility of both Nikes and Sunglasses and the marginal utilities per dollar of Nikes and sunglasses.



The above graph shows the marginal utilities per dollar spent on Nikes and Sunglasses, the intersection between these curves shows the optimal choice for Cal’s. The optimal choice in the diagram represented by the capital letter ‘E’, the quantity of Nikes is measured on the vertical axis from left to right and the quantity of sunglasses measured from right to left. The marginal utility per dollar spent on Nikes and sunglasses are same at the quantity so it is considered as the optimal choice for him.

3. Cal’s consumption of Nikes increases from 1 to 2 as the price of Nikes falls. This is because of two effects, the substitution effect and income effect. The substitution effect says that as the price of Nikes falls, their opportunity cost falls so Cal now has to give up fewer pairs of sunglasses for 1 Nike. This makes Nikes more attractive, and Cal substitutes Nikes in place of sunglasses. The income effect says that as Nikes become cheaper, Cal gets richer in a real sense; he can now buy more goods. Since Nikes are a normal good, when the purchasing power of Cal’s income rises, he consumes more Nikes. Both effects contribute to the fact that as the price of Nikes falls, Cal’s consumption of Nikes increases.