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Case:
Utility, a pivotal concept in economic decision-making, quantifies satisfaction or pleasure derived from consuming goods. The principle of utility can assist individuals in making better decisions according to their priorities and preferences in different aspects of life. In Mr. Ali's budgetary calculations, the pursuit of utility guides him to make choices between coffee and pastries, showcasing the intrinsic link between satisfaction and resource allocation. Mr. Ali is a college student who is trying to maximize utility within his limited budget. He likes both coffee and pastries and has Rs.100 to spend on his daily demands. There is a nearby café that serves coffee and pastries, and he is trying to decide how to allocate his budget to maximize his utility.
Analyse Ali's choices and spending behaviour to understand how he optimizes his utility within his budget constraint. The following table provides the budget, prices, and affiliated utilities of both products.
|
Budget |
Rs. 100 |
|
|
Product |
Price |
Utility |
|
Coffee |
20 |
5 per
cup |
|
Pastries |
30 |
7 per
pastry |
Law of Diminishing Marginal Utility: The additional utility of consuming more of a good diminishes as the quantity consumed increases.
Requirements:
1. Calculate the total utility Mr. Ali can derive from his budget if he spends it entirely on coffee, entirely on pastries, or a combination of both.
2. How does Ali's budget constraint limit his choices in allocating his Rs.100?
3. Use the concept of the Law of Diminishing Marginal Utility to explain why Mr. Ali might choose a combination of coffee and pastries instead of consuming only one of them.
Answer:
1- Calculating Total Utility:
If Mr. Ali spends his entire budget on coffee:
Total cups of coffee he can buy = Rs. 100 / Rs. 20 per cup = 5 cups
Total utility from coffee = 5 cups * 5 utility per cup = 25 utils
If Mr. Ali spends his entire budget on pastries:
Total pastries he can buy = Rs. 100 / Rs. 30 per pastry ≈ 3 pastries (as he can't afford 4)
Total utility from pastries = 3 pastries * 7 utility per pastry = 21 utils
If Mr. Ali combines both coffee and pastries:
Let's say he allocates a certain amount to coffee and the rest to pastries.
For instance, if he buys 3 cups of coffee (Rs. 60) and 1 pastry (Rs. 30), he spends Rs. 90.
Utility from 3 cups of coffee = 3 cups * 5 utility per cup = 15 utils
Utility from 1 pastry = 7 utils
Total utility from this combination = 15 utils (coffee) + 7 utils (pastry) = 22 utils
2- Budget Constraint:
Mr. Ali's budget constraint of Rs. 100 limits the combinations of coffee and pastries he can buy. He cannot buy an unlimited amount of both; there's a maximum quantity he can afford within his budget.
3- Law of Diminishing Marginal Utility:
This law suggests that as a person consumes more of a good, the additional satisfaction (utility) gained from each additional unit decreases.
- Mr. Ali might choose a combination of coffee and pastries because of diminishing marginal utility. Initially, the first cup of coffee or pastry gives him a high level of satisfaction (5 or 7 utils respectively). However, as he consumes more of the same item, the additional satisfaction decreases. So, by combining both, he can maximize his total utility by balancing the diminishing satisfaction from each item.
Choosing a combination allows him to enjoy some variety while maximizing the total satisfaction he can derive from his limited budget.
Therefore, to optimize his utility within the budget constraint, Mr. Ali might choose a combination of both coffee and pastries rather than consuming only one of them, as it allows him to maximize his overall satisfaction considering the diminishing marginal utility of each product.