In consumer choice, how should a consumer allocate spending?

• A. By spending on the most expensive item
• B. Where marginal utility per dollar is highest
• C. Where total utility is maximized ignoring price
• D. Based on brand popularity

Answer: (B)

When you decide how to spend your money, the goal is to allocate your funds so that the extra satisfaction from the next dollar spent is the same across all the goods you could buy. This is the idea behind the marginal utility per dollar rule: take the marginal utility of a good and divide it by its price to get MU per dollar. You should adjust your spending so that MU per dollar is equal for every item in your budget. If one good gives you more MU per dollar than another, you gain more total satisfaction by buying more of the first and less of the second, until the two MU per dollar values line up. The reason this works is that marginal utility tends to fall as you consume more (diminishing marginal utility), so the MU per dollar for each good changes as you buy more; you keep rebalancing until all equalize within your budget. Choices based on price alone, total utility ignoring price, or popularity don’t ensure that you’re getting the best possible total satisfaction for the money, because they don’t account for how much utility each dollar actually yields from each option.