Suppose that Sam allocates his income between milk and cereal Milk costs $2.50 p

Question

Suppose that Sam allocates his income between milk and cereal Milk costs $2.50 per gallon and cereal costs $5.00 per box. Sam has $50 per week to spend on these two goods. The following table shows Sam's preference for consumption bundles, as well as how Sam's marginal utility (MU) for milk and cereal, respectively, varies as consumption varies. Given the information provided here, how should Sam allocate his income between milk and cereal? Sam should purchase the following, as this is his optimal consumption bundle. and

Explanation / Answer

When consumption is optimal,

MU of milk / Price of milk = MU of cereal / Price of cereal

In following table, M: Milk and C: Cereal

So, Optimal consumption bundle is 4 gallons of milk & 8 packets of cereal (where ratio of MU to price is same for both).

Q(M) MU(M) P(M) MU(M) / P(M) Q(C) MU(C) P(C) MU(C) / P(C) 20 3 2.5 1.2 0 5 18 4 2.5 1.6 1 135 5 27 16 5 2.5 2 2 120 5 24 14 6 2.5 2.4 3 105 5 21 12 7 2.5 2.8 4 90 5 18 10 8 2.5 3.2 5 75 5 15 8 9 2.5 3.6 6 60 5 12 6 13 2.5 5.2 7 45 5 9 4 15 2.5 6 8 30 5 6 2 16 2.5 6.4 9 12 5 2.4 0 2.5 10 8 5 1.6

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