CAPE Economics
Unit 1
The Optimal Purchase Rule/Law of equi-marginal returns
The optimal purchase rule explains the choice of the best combination of goods with a limited
income. When shopping for grocery items, choices are made. The aim of the shopper is to buy
the most items for the least expenditure. The optimal purchase rule states that consumers allocate
their expenditure on many items in such a way that the ratio of satisfaction per dollar spent
(MU/p) is the same for all goods. In this way, total satisfaction (TU) reaches a maximum.
Expressed in formula, it is:
Mux = MUy = MUz
Px py pz
Where:
MU/x is the marginal utility of good x and px the price of good x.
MU/y is the marginal utility of good y and py the price of good y.
MU/z is the marginal utility of good z and pz the price of good z.
Let us again assume that satisfaction can be
measured in utils. If the price of a slice of pizza costs $2.00 and gives you 20 utils of satisfaction,
then $1.00 = 10 utils or MU/p = 10. If a soft drink costs $1.00 and yields 7 utils then each dollar
gives 7 utils or MU/p = 7.
If you only have $10.00, what is the best combination of pizza and soft drink that you can
purchase?
Consumers look for value (MU) for their money (price) and would rank the purchases that give
the highest satisfaction or MU. The consumer will go down the ranking as far as income allows,
ranking pizza and soft drink.
If a slice of pizza is $2.00 then the first pizza @ 10 utils per dollar = (20/2).
Choice 2 = second soft drink + first slice of pizza
= $2.00 + $2.00 = $4.00 (utils per dollar) = (9/1+20/2)
Choice 3 = third soft drink + 2 pizzas
= $3.00 + $4.00 = $7.00 (utils per dollar) = (7/1+15/2)
Choice 4 = fourth soft drink + 3 pizzas
= $4.00 + $6.00 = $10.00 (utils per dollar) = (5/1+10/2)
Choice 5 = fifth soft drink + 2 pizzas
= $5.00 + $4.00 =$9.00 (utils per dollar) = (1/1 +15/2)
Choice 4 is the best because the marginal utility per dollar in each case is 5/1 and the total
income of $10.00 is spent. If you check the table, you would readily observe that for this
combination: Total utility = 4 soft drinks (32 utils) + 3 pizzas (45 utils) = 77 utils
Combination 3 is: 3 soft drinks 35 utils 2 pizzas = 27 utils
= 62 utils
Expenditure = $7.00
Combination 3 achieves less TU and $3 left over.
The optimal purchase rule therefore underlines the highest value for money spent is 77 utils for
$10.00.
Helpful hint: the ratio of prices must be matched by the ratio of marginal utilities of each good.
Whenever the MU/price ratio of good X is greater than the MU/price ratio of another good Y, the
optimal purchase rule states that the rational consumer will restore equilibrium by consuming
more of good X and less of good Y. In this way the MU of X will fall and the MU of Y will rise.
The reason for this is that consuming more of good X reduces satisfaction per price while
consuming less of good Y raises MU/p. This falling and rising of the marginal utility to price
ratio for both goods eventually brings them to equilibrium when their respective ratios of MU/p
are the same. The same reasoning is applied to more than two goods consumed.
While the logic of utility theory is simple it may be criticised because it assumes that satisfaction
can be measured when in, fact it, may not be the same for everyone. Ceteris paribus assumptions
of price, income and other ‘fixed’ conditions of demand are also not fixed in a dynamic world.
Key points
A consumer will compare the marginal utility to price ratio, purchasing more of that good which
has a high MU/price ratio and less of that good with a low MU to price ratio. Consumer
equilibrium is achieved
where:
MUx = MUy = MUz
Px Py Pz
Purchasing more of one good lowers its MU while purchasing less of one good raises MU
(people value things more highly when they have less of them). Eventually, when the marginal
utilities are equal, equilibrium is achieved. This is called the optimal purchase rule. Although a
theory, utility analysis may explain certain types of economic behaviour.
Reference
Ramsingh, D. (2015). Economics for CAPE. United Kingdom: HarperCollins Publishers
Limited.
