Question

Consumers in Georgia pay twice as much for avocados as they do for peaches. However, avocados and peaches are the same price in California. If consumers in both states maximize utility, will the marginal rate of substitution of peaches for avocados be the same for consumers in both states? If not, which will be higher?

Short answer

No, the marginal rate of substitution of peaches for avocados is different in both states.

The marginal rate of substitution of peaches for avocados in California is higher than in Georgia.

Step-by-step solution

Utility for the consumers in Georgia and California

The law of equi-marginal utility states that a consumer should spend his limited income on different commodities. The last rupee spent on each commodity yields him an equal marginal utility to get maximum satisfaction.

Marginal rate of substitution for consumers in Georgia:

$$\begin{gathered} \frac{M{U}_{av}}{P_{av}}=\frac{M{U}_{pe}}{P_{pe}} \\ \frac{M{U}_{pe}}{M{U}_{av}}=\frac{P_{pe}}{P_{av}} \\ MR{S}_{av.pe}=\frac{1}{2}=0.5 \end{gathered}$$

Marginal rate of Substitution for consumers in California:

$$\begin{gathered} \frac{M{U}_{av}}{P_{av}}=\frac{M{U}_{pe}}{P_{pe}} \\ \frac{M{U}_{av}}{M{U}_{pe}}=\frac{P_{av}}{P_{pe}} \\ MR{S}_{av.pe}=1 \end{gathered}$$

Comparing the MRS of Georgia and California

MRS is used to show the quantity of good Y and good X, which are substitutable for one another. It includes bounded rationality in which consumers make purchasing decisions to satisfy their needs rather than achieve an optimal solution. It is related to the indifference curve.

From the computations above, it is evident that if consumers in both states maximize utility, the marginal rate of substitution of peaches for avocados in California is higher than in Georgia.