Microeconomics

Session 7

Sagnik Bagchi, Ph.D.

School of Business Management, NMIMS-Mumbai

Utility Maximizing Rule
To maximize satisfaction, the consumer should allocate his/her money income so that the last rupee
spent on each product yields the same amount of marginal utility.

Apple (Price = 100 Rs. piece) Orange (Price = 200 Rs. piece)
Unit of Marginal Utility Marginal Utility Income =
Marginal Marginal Consumption
Product per Rupee (MU/ per Rupee (MU/ Rs. 1000
Utility Utility
Price) Price)
1st 100 1 240 1.2 Orange 200
2nd 80 0.8 200 1 Apple, Orange 100+200+
200=500
3rd 70 0.7 180 0.9 Orange 200+500=
700
4th 60 0.6 160 0.8 Apple, Orange 100+200+
700=1000

χ
5th 50 0.5 120 0.6
6th 40 0.4 60 0.3
7th 30 0.3 40 0.2

18/07/2023 Microeconomics-MBA Core [2023-24], SB 2

Utility Maximizing Rule
Total Utility of the consumer: 960
 Apple = 100+80=180
 Orange = 240+200+180+160=780

 Other combinations of apples and oranges could have been brought too with income Rs. 1000, but
wouldn’t have maximized utility.
 For instance, 4 apples and 3 oranges would have yield 930 utils.
 Other combination of apples and oranges in which marginal utility of the last dollar spent is the
same for both goods, but these combinations are either unobtainable or don’t exhaust income
 4 apples and 5 oranges; 1 apple and 2 oranges

Generalized Rule: Consumers maximize utility when they allocate their income so that the last rupee
spent on product(s) yield equal amount of marginal utility.

This translates into marginal utility per rupee of expenditure on products must be equal

Marginal   utility   of   product   A Marginal   utility   of   product   B Marginal   utility   of   product   N

= = . . . =
Price   of   product   A Price   of   product   B Price   of   product   N

18/07/2023 Microeconomics-MBA Core [2023-24], SB 3

Budget Constraint and Line

Budget Constraints: Constraints that consumers face as a result of limited incomes.

The Budget Line budget line all combinations of goods for which the total amount of money
spent is equal to income (I).

Line A G (which passes through points

B, D, and E) shows the budget
associated with an income (I) of $80, a
price of food of (PF = $1) per unit, and a
price of clothing of (PC = $2)

The slope of the budget line is

18/07/2023 Microeconomics-MBA Core [2023-24], SB 4

Budget Line Shift
A change in income (with prices unchanged) causes the budget line to shift parallel to the original line

If income increases budget line parallel shifts upward and if income decreases budget line shifts
downward

When the income (I) was $80 budget

line is represented by L1 and as income
increases to $160, budget line shifts
upward to L2. When income decreases
to $40 budget line shifts downward to
L3.

This is because the intercept of the

budget line on both x and y-axis
changes.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 5

Budget Line Pivots/ Rotate
A change in prices (with income unchanged) causes the budget line to rotate about one intercept

Budget line represented in L1 denotes PF = $1 and

PC = $2 with income (I) of $80.

Decrease in PF = $0.5 causes the budget line to

rotate outward from L1 to L2.

Increase in PF = $2 causes the budget line to rotate

inward from L1 to L3

18/07/2023 Microeconomics-MBA Core [2023-24], SB 6

Consumer Equilibrium
 It must be located on the budget line.
 It must give the consumer the most preferred combination of goods and services.

A consumer maximizes satisfaction by choosing market

basket A. At this point, the budget line and indifference curve
U2 are tangent. No higher level of satisfaction (e.g., market
basket D) can be attained.

At A, the point of maximization, the MRS between the two

goods equals the price ratio

A consumer maximizes his/her utility/satisfaction at

a point where the slope of the budget constraint
equals the slope of the indifference curve.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 7