Utility: Total and Marginal Utility

Utility

• Utility serves as a measure of the satisfaction or happiness derived from consuming a good.

Total Utility vs. Marginal Utility

• Total utility represents the overall satisfaction from consuming all units of a good over a given period.
• Marginal utility denotes the additional satisfaction gained from consuming one more unit of a good.
• Example: Consuming one pizza slice yields 10 units of satisfaction, and consuming two slices yields 15 units; the marginal utility of the second slice is five units.

Law of Diminishing Marginal Utility

• Marginal utility decreases as the consumption of a good increases.

Measuring Utility

• Assigning a monetary value can measure utility.
• Example: Paying £0.90 for cake indicates that the utility is at least £0.90.
• A piece of cake costs £0.90, so consuming two pieces makes sense.
• The first gives 120p of utility and the second gives 90p of utility, however, the first piece is the most valuable.
• The third piece would only give 60p of utility which is less than the value of the 90p price.

Optimum Level of Consumption

• The optimum level of consumption is reached when marginal utility equals price (MU = Price).
• Example: There is no value in paying 75p for cake if it only gives us 50p worth of utility.

Equi-Marginal Principle

• Individuals allocate resources so that the marginal utility per unit of expenditure is equal across all goods or activities.
• Marginal utility tends to decrease over time as more of a good is consumed or an activity is engaged in.
• Overall utility is maximised when individuals allocate resources to equalise the marginal utility-to-price ratio for all goods.
• Formula: MU1 / P1 = MU2 / P2 = MU3 / P3 = ... = MUn / Pn
• The principle suggests that consumers maximise satisfaction when the marginal utility per unit of money is the same for each commodity, assuming other factors remain constant.
• Also known as the law of substitution or the law of maximum satisfaction.
• It is used to determine consumer equilibrium when multiple commodities are consumed.

Assumptions of Equi-Marginal Principle

• Consumers have limited incomes.
• Consumers behave rationally.
• Consumers seek to maximise their utility.

Equi-Marginal Utility Example Table

• The table shows two products, x and y, are priced at $1 and $2 respectively.
• A consumer with $10 maximises utility when MU/P is equal for both products.
• In the table, this is where 4x and 3y are consumed, resulting in a total utility score of 235, i.e. (60+40+25+12 = 137) + (42+ 32+24 =98).

Application of Marginal Utility Principle:

• Case 1: When MU of A/Price of A > MU of B/Price of B
  • The consumer is not in equilibrium, getting more utility from the last $ spent on A than on B.
  • The consumer will reallocate spending to increase the quantity of A and decrease the quantity of B to achieve equilibrium.
• Case 2: When MU of A/Price of A = MU of B/Price of B
  • The consumer is in equilibrium, with no tendency to change, getting the same utility from the last $ spent on both goods, maximising total utility.
• Case 3: When MU of A/Price of A < MU of B/Price of B
  • The consumer is not in equilibrium and will reallocate spending to buy more of good B and less of good A.

Individual Demand Curve

• Derived from marginal utility by analyzing how a consumer's willingness to purchase a good changes with price.
• Illustrates the inverse relationship between price and quantity demanded, reflecting consumer preferences and diminishing marginal utility.

Limitations of Marginal Utility Theory

• Utility is subjective and cannot be objectively measured as it varies among individuals.
• Applying the marginal utility approach to multiple goods and services is complex, due to the interactions between different goods.
• The theory assumes that consumers act rationally to maximise utility, which behavioural economics suggests is not always true.
• People do not always focus on economic influences, and may act on impulse or feelings which affects spending decisions that are not explained by utility maximisation alone.
• It also assumes that enjoyment consistently increases as more is consumed
• An assumption is that successive units of a good consumed are always of the same consistency and quality.
• A final assumption is that overtime incomes and quality of goods remain constant.