Marginal Utility Theory

Marginal Utility theory examines the increase in satisfaction consumers gain from consuming an extra unit of a good.

Utility is an idea that people get a certain level of satisfaction / happiness / utility from consuming goods and service.

This utility is not constant. Often we get diminishing marginal utility. The first piece of chocolate cake gives more utility than the 7th piece.

Quantity (Q)Total UtilityMarginal Utility
1100100
217070
319020
4180-110
5140-4

In the above example, total utility (190) is maximised after just three pieces of chocolate cake.

 

Utility and Price.

  • One way to measure utility is to give the utility a monetary value.
  • For example, if I would pay £0.70 for a piece of cake, then we can say the utility is £0.70
  • If a piece of cake cost 70p, it would make sense to consume 2 pieces.
  • The first piece gives 100p of utility > than the price of 70p.
  • The second piece gives a utility equal to the price.

Consumer Surplus

This is the excess of what a consumer would have been prepared to pay compared to what they actually pay.

A Person’s Consumer Surplus from Petrol

consumer-surplus

In the above diagram, at Q 500 litres, the MU is 80p > than the price = 50p. Therefore, a rational consumer will increase consumption of petrol, until the MU of petrol equals the price at 50p and a quantity of 800.

Marginal Consumer Surplus = The excess of a person’s total utility from the consumption of a good (MU) over the price paid: MCS = MU – P

Optimum Level of Consumption

For one good, the optimum level of consumption would be to consume a quantity of the good unto the point where MU = Price.

There’s no point paying 75p for cake, if it only gives us 50p worth of utility.

Demand Curve and Marginal Utilty

Our demand curve is derived from our marginal utility.

If a good gives us more satisfaction, e.g. it becomes more fashionable, our MU and demand curve will shift to the right.

Choosing Between Different Goods.

In the real world, we are not just deciding how much of one good to buy. We are also deciding how to choose between different combinations of goods.

The Equi Marginal principle in consumption states that consumers will maximise total utility from their incomes by consuming that combination of goods where:

MUa = Pa
—–     —-

MUb = Pb

For example, suppose bread = £1 and Chicken = £2.

  • Chicken is twice as expensive. Therefore, it would make sense to choose a quantity of chicken, where the marginal utility of chicken was twice the MU of bread.
  • Therefore, you would tend to buy less chicken to make sure the marginal utility of chicken justified its higher price.
  • If chicken was giving three times as much marginal utility, but was only twice as expensive, it would make sense to buy more chicken until the marginal utility fell to that ratio.

 

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