At his current level of consumption, Evan gets twice as much marginal utility from an additional bottle of water as that from an additional bottle of soda. If the price of soda is $1.00 per bottle, then Evan is maximizing utility if the price of a bottle of water is:
A)$1.00
B)$1.50
C)$2.00
D)$.50

Question

Quizplus · Accepted Answer

To maximize utility, Evan should buy more of the good that provides more marginal utility per dollar. Since he gets twice as much marginal utility from an additional bottle of water compared to soda, but both items cost the same, he should buy more water and less soda. However, at some point, the marginal utility per dollar of water will decrease and the marginal utility per dollar of soda will increase until they are equal. At that point, Evan will have maximized his utility.

Let's say Evan is willing to pay up to $x for a bottle of water. Since he gets twice as much marginal utility from water as soda, then the marginal utility per dollar from water is twice as much as the marginal utility per dollar from soda. Therefore:

MUw/$x = 2(MUs/$1)

Solving for x:

MUw/$x = MUw/$2 = MUs/$1

MUw = 2MUs

Since we know that soda costs $1, we can assume that it provides one unit of marginal utility, or MUs = 1. Therefore, we can plug this back into the equation to find the price Evan is willing to pay for water:

2MUs = MUw

2(1) = MUw

MUw = 2

So, Evan is willing to pay up to $2 for a bottle of water, which means he should buy more water and less soda to maximize his utility. Therefore, the correct answer is C) $2.00.

At His Current Level of Consumption, Evan Gets Twice as Much