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Economics explained


Behavioral economics

The optimum combination of goods consumed

The optimum combination of goods consumed

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We can use marginal utility analysis to show how a rational person decides what combination of goods to buy. Given that we have limited incomes, we have to make choices.

The equi-marginal principle

The rule for rational consumer behaviour is known as the equi-marginal principle. This states that a consumer will get the highest utility from a given level of income when the ratio of the marginal utilities is equal to the ratio of the prices. This is when, for any pair of goods, A and B, that are consumed:

Say that the last apple🍎 you ate gave you three times as much utility as the last banana. Yet an apple🍎 only costs twice as much as a banana🍌!

You would obviously gain by increasing your consumption of apples🍎 and cutting your purchases of bananas🍌.

But as you switched from bananas to eating more apples🍎, the marginal utility of eating apples🍎 would fall due to diminishing marginal utility (i.e you get tired of eating apples).

Conversely, the marginal utility of bananas🍌 would rise.

To maximise utility you would continue this substitution of apples🍎 for bananas🍌 until:

The ratios of the marginal utilities (MUA🍎/MUB🍌)

The ratio of the prices of the two fruits (PA🍎/PB🍌).

At this point, no further gain can be made by switching from one fruit to another. This is the optimum combination of apples🍎 and bananas🍌 to consume.

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