Micro CHAPTER 1.6:

CHAPTER SUMMARY

When we first introduced the idea of decisions on the margin, we made a simple yes/no decision about whether to buy something. However, in the real world, we have limited money and almost unlimited options about how to spend it. Marginal analysis can help us understand how people spend their limited money to get the most utility possible.

To practice basic marginal analysis, we will assume that a person will spend all of their money to buy some amount of two different items. They want to maximize their marginal utility per dollar (MU/P). If a water bottle gives me $3 of marginal utility and costs me $2, its MU/P is 1.5 ($3 divided by $2). If popcorn gives me $4 of marginal utility and costs $2, then its MU/P is 2 ($4 divided by $2). If I only have $2, I would choose to buy the popcorn, because it gives me higher MU/P.

However, now imagine that I have $6, and can spend it on any combination of water and popcorn. See the charts below for the marginal utility of each as I buy more.

If I have $6, I would spend the first $2 on popcorn, because that first popcorn has the highest marginal utility per dollar. However, the next popcorn would only have 0.5 MU/P, whereas buying a water bottle would give me 1.5 MU/P. Now, I have $2 left. I can spend it on water and receive 1 MU/P, or buy popcorn and receive 0.5 MU/P, so I would choose to buy the water. If they both have MU/P less than 1, I would buy neither. In the end, I would choose to buy 2 water bottles and 1 popcorn.

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EXTENSION