Due Tuesday, September 18, 2018, in class Please hand in neatly written answers

Question

Due Tuesday, September 18, 2018, in class Please hand in neatly written answers to the problems below. Show all of your work. Answer all parts to all questions! 1) Suppose that McNulty's marginal utility for cups of coffee is constant at 4.5 utils per cup, no matter how many cups he drinks. On the other hand, his marginal utility per doughnut is 10 for the first doughnut he eats, 8 for the second he eats, 6 for the third he eats, and so on (that is, declining by 2 utils per additional doughnut). In addition, suppose that coffee costs $1 per cup, doughnuts cost $1 each, and Omar has a budget that he can spend only on doughnuts, coffee, or both. How big would that budget have to be before he would spend a dollar buying a first cup of coffee?

Explanation / Answer

Solution: Since a cup of coffee and doughnut both cost $1 and the marginal utility is 4.5 and 10 utils for coffee and doughnut respectively, McNulty will continue to purchase doughnut until his marginal utility from doughnut becomes either equal to less than marginal utility from coffee which is 4.5 utils.

Thus his budget has to be $3 so that he could purchase 3 units of doughnuts.The marginal utility of 3rd unit is 6 utils and that of 4th unit is 4 utils. So he will prefer to buy his first cup of coffee because the marginal utility of coffee is more than the marginal utility of 4th unit of doughnut.

Hence, the answer is $3.

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