Marginal Utility - Definition
Marginal utility is a measure that defines the enjoyment or satisfaction a consumer gains from consuming each additional unit of a product. It focuses on calculating utility beyond the consumption of the first product.
What is Utility?
To understand what marginal utility means, we will first have to understand what utility is.
Consider this, when a consumer buys a product they assign value to that said product. This value is known as “utility” - which is a measure of satisfaction a person receives from consuming the said product.
Consumers constantly think about utility while making their purchase decisions. It directly points to a consumer’s willingness to spend. So by determining the utility of a product/service you can then predict market behavior and price your products appropriately.
Utility Quantified as UTILS
Since utility is a value that measures consumer satisfaction, it can be quantified into units called “utils”. To use this unit, you can also place a currency value on utility. For example, you can place a dollar amount on a single unit of a good or service. So if you consider a pack of chips, the utility can be 5 util dollars.
The util dollar amount would be the value you assign to the product. So it will point to the amount the product is worth to you, regardless of the actual price.
In fact, if the utility amount is lesser than the actual amount, then in this case you would mostly decide to not purchase this product.
What is Total Utility?
Total utility basically is the sum of utility gained by purchasing a certain amount of products.
So suppose you decide to buy 4 bags of chips for a road trip. You enjoy the first bag very much, so you assign 5 utils to the first bag.
Since you enjoyed the first bag so much, you go for the second and third bag and now you are increasingly enjoying consuming chips. Let’s say, the utility here is 7 and 8 for the 2nd and 3rd bags.
Now by the time you reach the fourth bag you start feeling a little bit sick and nauseous. Your experience is not as great as with the first three bags. So let’s say the utility here is 3 utils.
So the total utility of your purchase is = 5 + 7 + 8 + 3 = 23 utils.
So as you continue to consume the same product over time the increase in utility becomes less and less.. This change in utility is called the marginal utility.
What is Marginal Utility?
Now coming back to marginal utility, it’s clear now that it is essentially the utility of each additional unit of a product consumed. So in our previous example, the utility of our fictional bags of chips kept increasing marginally, but its marginal utility kept decreasing.
No. of Bags of Chips
5 = 5 - 0
2 = 7 - 5
1 = 8 - 7
-5 = 3 - 8
Since the satisfaction increases as you consume the 1st, 2nd and 3rd bag of chips, the marginal utility is a positive value. But as you consume the 4th bag your satisfaction decreases, so the marginal utility here is negative.
The fact that the marginal utility gradually decreases over the course of consumption is called the “Law of diminishing utility”. So the law essentially states that for every newly added unit of product the marginal utility decreases.
Types of Marginal Utility
There are basically three types of marginal utility:
- Positive marginal utility- This is when there is an increase in utility after consuming the next unit. For example, after you consume the second bag of chips the utility increases, so the marginal utility is positive.
- Negative marginal utility- This is when there is a decrease in the utility after consuming the next unit. For example, after you consume the fourth bag of chips the utility decreases, so the marginal utility is negative.
- Zero marginal utility- This is when there is no change in the utility between two corresponding units. If, suppose your level of satisfaction remains the same after consuming the next bag of chips then the marginal utility is zero.
Origin of Marginal Utility
The concept of utility first emerged in the 19th century when economists were attempting to explain the determination of prices. The term “marginal utility” is credited to the Austrian economist Friedrich von Wieser.
The prevailing idea with respect to the determination of prices was that utility and rarity of a product had an effect on consumer economic decisions. This, in extension, had an effect on prices as well.
The common belief was that essential products have higher utility but economists noticed that consumers were spending more on non-essential items like diamonds. This is known as the paradox of value. Economists then came to the conclusion that rarity was also a factor that contributed to utility. Economists also preferred to think in terms of marginal utility over quantifying the utility value.
How to find Marginal Utility
Now coming to the main question - How to find marginal utility?
The marginal utility is basically the total utility change divided by the change in the number of goods.
Marginal utility = Change in Total Utility / Change in Units
Change in Total Utility - Current total utility subtracted by previous total utility
Change in Units - Current units amount subtracted by previous units amount
The “current” utility is basically the utility of the unit of goods you are calculating marginal utility for.
The steps to calculate marginal utility are as follows:
- Define the total utility of the current unit of goods.
- Define the total utility of the previous unit of goods.
- Find the difference between 1 and 2 (1 - 2)
- Define the number of units in the current unit of goods.
- Define the number of units in the previous unit of goods.
- Find the difference between 4 and 5 (4 - 5)
- Divide the 3 by 6 to get the marginal utility.
Example Calculation of Marginal Utility
Now let’s follow these steps so you’ll know how to find marginal utility for this example problem.
Suppose a person X has dumplings for lunch every day. The dumplings cost $2 each but person X really likes dumplings so they assign a utility value of $4 to each dumpling.
On the first day of their visit to the dumpling shop, person X has 3 dumplings. For the 3 dumplings, person X assigns utility values 4, 6, and 4 respectively.
So, here the total utility is,
Total utility = 4 + 6 + 4 = 14
No. of units = 3
On the next day, the person X is extra hungry for dumplings, so he ends up consuming 6 dumplings. He assigns a utility of 4, 6, 7, 6, 4, and 2 to each of the dumplings he consumes.
So the total utility is,
Total utility = 4 + 6 + 7 + 6 + 4 + 2 = 29
No. of units = 6
So, to find the marginal utility, we first find the difference in total utility
Difference in Total Utility = 29 - 14 = 15
Difference in units consumed = 6 - 3 = 3
Therefore, now the marginal utility is
Marginal utility = Change in Total Utility / Change in No. of Units = 15/3 = 5
So in this case person X places a marginal utility is 5 on each dumpling they consumed.