UTILITY PROBLEMS Ordinal and Cardinal Approach
Compiled by M. Moses
EXERCISE 1 – CHAPTER 6
Maxine has R8.00 available to spend on cookies and milk. The price of cookies is
R2.00 per unit and the price of milk is R1.00 per unit. The total utility she receives
from the consumption of cookies and milk is as follows:
Cookies Milk
Units Total Utility Marginal MU Total Utility Marginal MU
Utility P Utility P
0 -- --
1 24 16
2 40 29
3 52 41
4 58 49
5 62 54
6 64 58
2
EXERCISE 1 – CHAPTER 6
1. Complete the above table reflecting Maxine’s consumer behaviour for
cookies and milk.
2. What two conditions have to be met to satisfy the principle of consumer
equilibrium?
3. Which combination of cookies and milk satisfies the consumers’ equi-
marginal satisfaction?
4. The price of cookies decreases to R1.00 per unit. Will Maxine still buy the
same quantity of cookies as before? Explain using your knowledge of
utility theory.
3
EXERCISE 1 – CHAPTER 6
1.1 Complete the above table reflecting Maxine’s consumer behaviour for
cookies and milk.
Cookies Milk
Units Total Utility Marginal MU Total Utility Marginal MU
Utility P Utility P
0 -- -- -- -- -- --
1 24 24 12 16 16 16
2 40 16 8 29 13 13
3 52 12 6 41 12 12
4 58 6 3 49 8 8
5 62 4 2 54 5 5
6 64 2 1 58 4 4
4
EXERCISE 1 – CHAPTER 6
1.2 What two conditions have to be met to satisfy the principle of consumer
equilibrium?
Rule for equi-marginal satisfaction:
(a) The weighted marginal utilities for all goods must be equal. (OR) The
marginal utility per rand (currency) must be equal.
(b) The amount spent must be affordable. (OR) The last available rand must be
spent.
5
EXERCISE 1 – CHAPTER 6
1.3 Which combination of cookies and milk satisfies the consumers’
equi-
marginal satisfaction?
Applying conditions:
Where MUc/Pc = MUm/Pm Then PcQc + PmQm = I
12 = 12 (2)(1) + (1)(3) = 5 < (Income = 8)
Where MUc/Pc = MUm/Pm Then PcQc + PmQm = I
8 = 8 (2)(2) + (1)(4) = 8 = (Income = 8)
Maxine buys two units of cookies and four units of milk to satisfy both utility-
maximising conditions.
6
EXERCISE 1 – CHAPTER 6
1.4 The price of cookies decreases to R1.00 per unit. Will Maxine still buy the
same quantity of cookies as before? Explain using your knowledge of
utility theory.
When Pc = R2.00, the consumer equilibrium is where the weighted marginal utilities
are equal at 8. Price of cookies falls, thus Pc = R1.00.
Now, MUm/Pm = 8/1 = 8 and MUc/Pc = 16/1 = 16, implying MUm/Pm < MUc/Pc.
To re-establish equilibrium, Maxine should buy more cookies or less milk.
This decision is based upon the law of diminishing marginal utility, which states that as
one consumes an extra unit of a good, the marginal utility gained diminishes.
Maxine will not be able to purchase the same quantity of cookies as before.
7
BMES – QUESTION 19
The price of tea is R3 per cup and the price of a hamburger is R10. Piet receives
an income of R32. Assume Piet spends all her income on the two goods. Use
the table below to decide how many cups of coffee and hamburgers Piet
should buy to maximize his utility.
Number of units TU coffee TU hamburgers
1 90 130
2 150 230
3 192 310
4 222 380
5 240 430
8
EXERCISE 2 – CHAPTER 7
Assume Ada purchases two goods, namely apples and oranges. The per-unit
prices of apples and oranges are R2 and R3 respectively. Ada’s budget constraint
is R60.
1. Plot Ada’s budget line. Clearly label X-intercept and Y-intercept.
2. Assuming the per-unit price of apples reduces by 50%, ceteris paribus.
Plot Ada’s new budget line in the same figure as in 2.1. Once again,
clearly label the two intercepts.
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EXERCISE 2 – CHAPTER 7
1. Plot Ada’s budget line. Clearly label X-intercept and Y-intercept.
I/Pa = 60/2 = 30… x-intercept I/Po = 60/3 = 20… y-intercept
2. Assuming the per-unit price of apples reduces by 50%, ceteris paribus.
Plot Ada’s new budget line in the same figure as in 2.1. Once again,
clearly label the two intercepts.
Quantity of oranges
I/Pa = 60/1 = 60… x’-intercept
20
0 3 60 Quantity of apples
0
10
EXERCISE 3 – CHAPTER 7
Jane receives utility from days spent traveling on vacation domestically (D) and
days spent traveling on vacation in a foreign country (F), as given by the utility
function U(D,F) = 10DF where marginal utility for domestic travel (MUD) is 10F
and the marginal utility for foreign travel (MUF) is 10D . In addition, the price of a
day spent traveling domestically is R100, the price of a day spent traveling in a
foreign country is R400, and Jane’s annual travel budget is R4000.
1. Derive and graph the linear equation for the budget line.
2. Graphically illustrate the indifference curve with a utility of 1000.
3. Find the utility maximising combination of the two goods.
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EXERCISE 3 – CHAPTER 7
3.1 Derive and graph the linear equation for the budget line.
G i v e n : I R 4 0 0 0 ; P D R100; P F R 4 0 0
I PD D PF F
4 0 0 0 1 0 0 D 4 0 0 F ...budget lineequa ti on
4000 100D 400F
1 0 1 4 D F ...linear equation
12
EXERCISE 3 – CHAPTER 7
3.2 Graphically illustrate the indifference curve with a utility of
1000.
Given :U 1000
U ( D , F ) 1 0 D F ...utility f u n c t i o n
1000 10DF
100 DF
1 0 0 D 5 0 ...If F 5 0
2 D
100 D25 ...If F 2 5
4 D
100 D20 ...If F 2 0
5 D
100 D10 ...If F 1 0
10 D 13
EXERCISE 3 – CHAPTER 7
3.3 Find the utility maximising combination of the two goods.
PD
Utilityismaximisedwhere M R S
P
F
MU
MRS D 10F F
MU 10 D D
F
P
D 100 1
P 400 4
F
Substituteintoutilitymaximisingcondition
P
MRS D
P
F
F 1
D 4
4F D
Substituteintolinearequationforbudgetline
F 10 1 D F 10 1 D
4 4
F 10 144F 5 10 14 D
2 F 10 14 D 5
F 5 D 20 14
EXERCISE 3 – CHAPTER 7
Foreigntravel
10
A
5
U=10DF
0 20 40 Domestictravel
15
