Describe the utility maximizing rule.?

Question

If possible, if you respond can you be detailed as possible so that I can understand this.

Answer 1

The utility maximizing rule can be stated in several (equivalent) ways:

1. Marginal Rate of Substitution = Price ratio

OR MRS= P1/P2

This represents the point where the indifference curve is tangent to the budget restriction and it indicates that exactly at that point, with that combination of good 1 and good 2 the consumer is getting the most satisfaction it can get, given his preferences (represented by the indifference curve) and his budget. He cannot do any better in terms of personal satisfaction than at exactly this combination.

2. Marginal utility ratio=price ratio

OR (MU1 / MU2)= (P1/P2) which is the same as (MU1 / P1) = (MU2 / P2)

This is equivalent to the previous one, but can be a bit more intuitive. It essentially means that the combination of good 1 and good 2 that give the consumer the highest possible satisfaction, given his preferences and budget, is where the last dollar spent on either good gives the individual the same amount of additional utility, regardless of which good he consumes.

That is, at the point where, if given one more dollar, the consumer would be indifferent between spending it on either good 1 or good 2 because they both will give him the same additional utility. Otherwise, say he is given an additional dollar and decides that good 1 gives him more additional utility than good 2, then rationally he would buy one more unit of good one, but if this is the case then he still can do better by buying more of good 1 up to the point where the marginal utilities are equal and he is indifferent between both goods, then at this point he is effectively maximizing utility.

In mathematical terms this means that the slope of the indifference curve (MRS=ratio of marginal utilities) is equal to the slope of the budget line (price ratio).

Hope it helps!