Author Question: A consumer allocates his budget according to rules of utility maximization. What are the rules of ... (Read 56 times)

bobbie · **on:** Jun 29, 2018

A consumer allocates his budget according to rules of utility maximization.

What are the rules of utility maximization and how do they explain the paradox of value, which is that diamonds are expensive but useless, while water is inexpensive but essential?

Question 2

Oligopoly differs from perfect competition because a single competitive firm's behavior does not affect the behavior of its competitors while the behavior of a single oligopolistic firm does affect the behavior of its rivals.

Indicate whether the statement is true or false

C.mcnichol98 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The rules of utility maximization are to allocate the entire available budget and consume the combination of goods and services that make the marginal utility per dollar equal for all goods and services. Equating the marginal utility per dollar is what explains the paradox of value. People consume a great deal of water. Because they consume a lot of water, the marginal utility of water is quite low. However, people have only a few diamonds. Hence the marginal utility of a diamond is quite high. Thus for the marginal utility per dollar of water to equal that of diamonds requires that the price of water be low and the price of diamonds high. Note, however, that this condition says nothing about the total utility from water or the total utility from diamonds. Because water is essential to life, its total utility is tremendous. Because diamonds are not essential, their total utility is much smaller.

Answer to Question 2

TRUE