1.2.2 Diminishing Marginal Utility

Question 1

What is Utility?

Answer 1

• Utility refers to the satisfaction, well-being, or value that an individual derives from consuming goods and services.
• It is a concept used to quantify the subjective preferences and choices of individuals when they make decisions about what to consume or how to allocate their resources.
• Utility serves as a theoretical construct to help economists understand and model human behaviour.
• The idea of utility is central to the field of microeconomics, which focuses on the behaviour of individual consumers and firms in the market.

Question 2

What is Marginal Utility?

Answer 2

• Marginal utility refers to the additional satisfaction or utility gained from consuming one more unit of a good or service.

e.g. Imagine Sarah is eating chocolate bars. Her total utility from consuming different quantities of chocolate bars is as follows:
Consuming 1 chocolate bar: Total utility = 20 units (marginal utility = 20 units)
Consuming 2 chocolate bars: Total utility = 35 units (marginal utility = 15 units)
Consuming 3 chocolate bars: Total utility = 45 units (marginal utility = 10 units)
Consuming 4 chocolate bars: Total utility = 50 units (marginal utility = 5 units)
Consuming 5 chocolate bars: Total utility = 52 units (marginal utility = 2 units)

Question 3

What is the Law of Diminishing Marginal Utility?

Answer 3

• The law of diminishing marginal utility states that as a person consumes more units of a particular good or service while keeping the consumption of other goods constant, the additional satisfaction or marginal utility gained from each additional unit will decrease.
• In other words, the more you consume of something, the less extra satisfaction you derive from consuming even more of it.
• The law of diminishing marginal utility explains why the demand curve is downward sloping.
• The higher the quantity bought, the lower the marginal utility (the utility from consuming the last one) derived from consuming the product. E.g. Coca Cola
• Buyers will only pay low prices for relatively high amounts purchased, but they will pay higher prices if the quantity available for sale is lower. E.g. Diamonds

Question 4

What is the relationship between Marginal Utility and Demand?

Answer 4

• The hypothesis of diminishing marginal utility supports a downward sloping demand curve
• Consumers generally seek to maximise their overall satisfaction or utility when making consumption choices.
• As they consume more of a particular good, the extra satisfaction they gain from each additional unit becomes smaller.
• This means that consumers are willing to pay less for each subsequent unit of a good, as it provides them with diminishing additional satisfaction.
• People are willing to buy more of a good when its price is lower, because the reduction in price makes each additional unit more valuable in terms of the satisfaction it provides.

Question 5

What is Disutility?

Answer 5

• Disutility is the opposite of utility.
• While utility represents the satisfaction or benefit gained from consuming goods or services, disutility refers to the negative feelings, discomfort, or displeasure associated with certain activities, goods, or services.

E.g. Spam advertising, Waiting in lines at shops, Traveling in crowded uncomfortable public transport

Question 6

When is Total Utility Maximised?

Answer 6

• Total utility for a single product is maximised when a consumer consumes the quantity of that product where the marginal utility (additional satisfaction gained from consuming one more unit) is zero.
• In other words, it’s the point when consuming an additional unit of the product no longer provides any extra satisfaction.

Question 7

How do you Maximise Total Utility?

Answer 7

• Rational choice theory assumes that consumers always behave rationally in allocating their limited budget between different products to maximise total satisfaction from their purchases.
• With one product, utility is maximised when marginal utility is zero
  With multiple products, the condition for maximising utility is that a consumer equalises the marginal utility per pound spent
  Condition for maximising total utility is:
  MUA/PA = MUB/PB
  Where: MU is marginal utility, P is price of a given product and A + B are the two products