Mrs. Simpson buys loaves of bread and quarts of milk each week at prices of $1 and 80 cents, respectively. At present she is buying these products in amounts such that the marginal utilities from the last units purchased of the two products are 80 and 70 utils, respectively. Is she buying the utility-maximizing combination of bread and milk? If not, how should she reallocate her expenditures between the two goods?

See answer below.

Explanation:

The maximum utility theory states that more money should be allocated to resources that offer the highest utility per dollar spent.

In order to solve this question, we will calculate the utility per dollar as follows;

Utility per dollar = marginal utility / price

For bread:

Utility per dollar = 80/1 = 80

For milk:

Utility per dollar = 70/0.8 = 87.5

From the calculations above, we can see that more utility is gotten from the purchase of milk.

Therefore she is not buying the utility-maximizing combination of bread and milk, and more money should be spent on the purchase of milk.