Enter the marginal utility of product A, the price of product A, and the marginal utility of product B to calculate the price of product B using the utility maximization model.
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Maximum Utility Formula
The following formula shows the relation between the marginal utility and price of two different products using the utility maximization model.
Mu(a)/P(a) = Mu(b)/P(b)
- Where Mu(a) is the marginal utility of product A
- Mu(b) is the marginal utility of product B
- P(a) is the price of product A
- P(b) is the price of product B
Maximum Utility Definition
Maximum Utility, of utility maximization as it’s more commonly referred to, is the process by which companies go about achieving the highest level of satisfaction from economic decisions.
How to calculate utility maximization?
- First, determine the marginal utility of the first product.
For this example problem, the marginal utility of product A is .75.
- Next, determine the price of the product at this marginal utility.
The price is found to be $5.00 at this utility.
- Next, determine the marginal utility of product B.
For this problem, the marginal utility of B is found to be .60.
- Finally, calculate the price of product B using utility maximization.
Re-arranging the equation above, we get P(b) = MU(b) / (Mu(a)/P(a) = .60/(.75/5) = $4.00.
Why is maximum utility important?
The utility maximization theory is an important concept to understand for both businesses and consumers. The theory states that consumers will spend in a way that maximizes their utility. Knowing this, businesses can price products to try to entice consumers to buy their products. On the flip side, consumers can understand that businesses will do this and make more conscious decisions on spending.