Question

Explain the idea of utility maximization as it relates to rational choice theory. Make sure to include important and relevant concepts that we have covered in the course thus far, such as consumer decisions and preference, budget constraints, and income and substitution effects.

Answer 1

The Utility Maximization-

the utility maximization model is based on the following assumptions-

1. Consumers are assumed to be rational, trying to get the most value for money.

2. consumers have clear preference for various goods and services, thus they know their Marginal Utility for each successive units of the product.

3. Every Item has a price tag. Consumers must select among alternative goods with their limited money incomes.

4. Consumers' incomes are restrained as their individual resources are limited. They face a budget limitation.

The utility maximization states-

Consumers decide to allocate their money incomes so that the last dollar spent on each product bought yields the similar amount of extra Marginal Utility.

The algebraic statement is that consumers will allocate income in such a way that:

MU of Product X = MU of Product Y =MU of Product Z