What Marginal Utility Says About Consumer Choice

As an economic concept, marginal utility can be used by businesses to understand customer behavior, set prices for goods and services, and decide which products to innovate or upgrade. The law of diminishing marginal utility is often used to justify progressive taxes. The idea is that higher taxes cause less loss of utility for someone with a higher income. In this case, everyone gets diminishing marginal utility from money. Suppose that the government must raise $10,000 from each person to pay for its expenses.

Paradox of water and diamonds

Total utility, instead, measures the total amount of satisfaction of you get from all the units you consume of a good or service. Positive marginal utility causes total utility to increase, while negative marginal utility decreases total utility. Mr. Higgins’s marginal utility from movies is typical of all goods and services. Suppose that you are really thirsty and you law of diminishing marginal utility given by decide to consume a soft drink.

Law of Demand

If the average income is $60,000 before taxes, then the average person would make $50,000 after taxes and have a reasonable standard of living. Higher marginal utility often leads to greater customer satisfaction because consumers feel they are getting their money’s worth. This can lead to brand loyalty over time, as well as word-of-mouth recommendations. Marginal utility helps assess consumers’ spending patterns, which has wide-ranging effects, such as helping businesses determine how to set prices for their goods and services. Consumers must carefully determine how they spend their money and they will always direct it towards where they are receiving the most utility.

After that, because the marginal utility of each additional backpack decreases, the business must decrease the cost per unit in order to entice shoppers to purchase more units. The law of diminishing marginal utility can also affect what goods and services businesses offer to customers, as it encourages a certain level of diversification. In the above example with the pizza, if the consumer knows they won’t want the fourth and fifth slices of pizza, they might not buy them in the first place.

Here it may be noted that the utility of then successive units consumed diminishes not because they are not of inferior in quality than that of others. We assume that all the units of a commodity consumed are exactly alike. The utility of the successive units falls simply because they happen to be consumed afterwards. When buying extras of an item provides more satisfaction, this is considered to be a situation of their providing positive marginal utility. For instance, a buy-two-get-one-free offer for something like cashmere sweaters would be a case of positive marginal utility, because buying two sweaters means you get a third sweater.

Law is Based Upon Three Facts:

The concepts of Total Utility and Marginal Utility are indispensable for understanding how utility functions work. Total utility is described as the overall satisfaction obtained from consuming a certain quantity of a good, while marginal utility refers to the satisfaction obtained from consuming one more unit of that good. When Cramer and Bernoulli introduced the notion of diminishing marginal utility, it had been to address a paradox of gambling, rather than the paradox of value. The marginalists of the revolution, however, had been formally concerned with problems in which there was neither risk nor uncertainty. So too with the indifference curve analysis of Slutsky, Hicks, and Allen. In an economy that uses money, the marginal utility of a given quantity of money is equivalent to the marginal utility of the best good or service that could be purchased with that money.

Negative Marginal Utility

1. If the shop only marketed a single product, consumers would likely grow tired of that product; its marginal utility would diminish.
2. It might be difficult to eat because you’re already full from the first three slices.
3. “Utility” is an economic term used to represent satisfaction or happiness.
4. Utility is the degree of satisfaction or pleasure a consumer gets from an economic act.

Change in number of units is found by subtracting the previous number of units from the current number of units (Q2-Q1). From this one change in behavior, we do not know whether or not he is actually maximizing his utility, but his decision and explanation are certainly consistent with that goal. It must be because they provide you with satisfaction—you feel better off because you have purchased them. There are some exceptions or limitations to the law of diminishing utility. �The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that already has�.

In other words, it shows that the more a person consumes a product, the lesser satisfaction he or she will derive from each additional unit. This law plays a major role in understanding consumer behavior, pricing, and decision-making in economics. The law of diminishing marginal utility states the marginal utility from an additional unit of consumption declines as the quantity of consumed goods increases. Consumers choose their baskets of goods by equating marginal utility of a good to its price, which is a marginal cost of consumption. It states that when people go to the market for the purchase of commodities, they do not attach equal importance to all the commodities which they buy.

The first movie Mr. Higgins sees increases his total utility by 36 units. The second increases his total utility by 28 units; its marginal utility is 28. The seventh movie does not increase his total utility; its marginal utility is zero. Mr. Higgins’s marginal utility curve is plotted in Panel (b) of Figure 7.1 “Total Utility and Marginal Utility Curves” The values for marginal utility are plotted midway between the numbers of movies attended. The marginal utility curve is downward sloping; it shows that Mr. Higgins’s marginal utility for movies declines as he consumes more of them.

We could extend the analysis to cover several periods and generate the same basic results that we shall establish using a single period. We will also carry out our analysis by looking at the consumer’s choices about buying only two goods. Again, the analysis could be extended to cover more goods and the basic results would still hold.