Question

Suppose that Peter's marginal utility for cups of coffee is constant at 2.5 utils per cup no matter how many cups he drinks. On the other hand, his marginal utility per doughnut is 12 for the first doughnut he eats, 11 for the second he eats, 10 for the third he eats, and so on (that is, declining by 1 util per additional doughnut). In addition, suppose that coffee costs $1 per cup, doughnuts cost $1 each, and Peter has a budget that he can spend only on doughnuts, coffee, or both. How big would that budget have to be in order for him to buy his first cup of coffee? Please do not input the sign, if your answer is $2, please input 2 for the answer. 10

Answer 1

Ans. Peter will consume the donuts till the quantity where the marginal utility of donuts is greater than or equal to the marginal utility of coffee i.e. 2.5.

So, he will consume 9 units of donuts with marginal utility of 3 for the last unit of the donut consumed and if one more unit of donut is consumed, the marginal utility from donuts fall below $2.5 to $2. So, after 9th unit of donut he will consume coffee as it gives higher utility of $2.5.
Thus, required budget is = $9 + $1 = $10

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