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Diminishing marginal utility and the rational spending rule

# Diminishing marginal utility and the rational spending rule...

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12/14/10 Diminishing marginal utility and the rational spending If diminishing marginal utility is true, we can derive a rational spending rule The rational spending rule: The marginal utility of the last dollar spent for each good is equal

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12/14/10 The rational spending rule Why is the rational spending rule true with diminishing marginal utility? Suppose that the rational spending rule is not true We will show that utility can be increased when the rational spending rule does not hold true
12/14/10 The rational spending rule Suppose the MU per dollar spent was higher for good A than for good B I can spend one more dollar on good A and one less dollar on good B

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Unformatted text preview: Since MU per dollar spent is higher for good A than for good B, total utility must increase Thus, with diminishing MU, any total purchases that are not consistent with the rational spending rule cannot maximize utility 12/14/10 The rational spending rule The rational spending rule helps us derive an individuals demand for a good Example: Apples Suppose the price of apples goes up Without changing spending, this persons MU per dollar spent for apples goes down To re-optimize, the number of apples purchased must go down Thus, as price goes up, quantity demanded decreases...
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