Saturday, 22 July 2017

What is 'Marginal Utility'?

Marginal Utility

What is 'Marginal Utility'

Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important economic concept because economists use it to determine how much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases the total utility. Negative marginal utility is when the consumption of an additional item decreases the total utility.
BREAKING DOWN 'Marginal Utility'

Economists use the concept of marginal utility to measure happiness and pleasure, and how that affects consumer decision making. They have also identified the law of diminishing marginal utility, which means that the first unit of consumption of a good or service has more utility than the next units of consumption.
Example of Marginal Utility

The following example can demonstrate the concept of marginal utility. Imagine that a person has four bottles of water and purchases a fifth bottle of water. Next, imagine that a second person has 50 bottles of water and purchases one more bottle of water. The first person buying the fifth bottle of water will get far more utility from that fifth bottle of water because of its proportion to the total. This fifth bottle increases the total water by 25%. The second person gains far less utility from purchasing a 51st bottle of water, precisely because its proportion to the total is so low. This 51st bottle of water increases the total water by only 2%. As a person purchases more and more of a product, the marginal utility to the buyer gets lower and lower, until it reaches a point where the buyer has zero need for any additional units of the good or service. At that point, the marginal utility of the next unit equals zero.

The idea of marginal utility resulted from 19th-century economists attempting to explain the economic reality of price, which they believed was driven by a product's utility. This, however, led to a paradox that is commonly known as the "the paradox of water and diamonds," which is attributed to Adam Smith, author of The Wealth of Nations. The paradox states that water has a value far less than diamonds, even though water is vital to human life and diamonds aren't. Since marginal utility and marginal cost are used to determine price, the paradox is that the marginal cost of water is much lower than that of diamonds.
Total Utility

Total utility is the aggregate level of satisfaction or fulfillment that a consumer receives through the consumption of a specific good or service. Each individual unit of a good or service has its own marginal utility, and the total utility is simply the sum of all the marginal utilities of the individual units. Classical economic theory suggests that all consumers want to get the highest possible level of total utility for the money they spend.
BREAKING DOWN 'Total Utility'
Utility refers to the amount of satisfaction or happiness that is derived from a particular good or service, and is used in analysis of consumer preference within a marketplace. As part of the theory of the consumer or the consumer demand theory, consumer action is driven toward utility maximization by attempting to acquire the most satisfaction possible in the most affordable way.

Total utility includes the satisfaction derived from a particular good or service through the duration of its lifespan. For example, a cookie provides a level of total utility as determined by its singular consumption, while a bag of cookies may provide its total utility over the course of time it takes to completely consume all of the cookies in the bag, with each cookie consumed providing a level of marginal utility contributing to the total.
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