Marginal utility helps both statisticians and somebody put a quantifiable knowledge of worth on goods. Businesses use marginal utility to define the completion of a product or service and adjust production as needed. Large corporations use complex calculations, but the marginal utility can be found with a simple formula. In this article, we discuss what marginal utility is and how to calculate it with an example.
Marginal Utility
Marginal utility appraises customer, client, and consumer satisfaction after obtaining more units of goods or services. Economists use this measurement to estimate how much of a good or service customers want to buy. When more of the same unit is consumed and total utility rises, positive marginal utility occurs. When the opposite occurs, the product experiences negative marginal utility.
The third common type of marginal utility is known as zero marginal utility. This occurs when having more than one of an item fails to bring further satisfaction to a customer. For example, zero marginal utility occurs if a consumer purchases two of the same issue of a comic book and the second copy provides no additional value.
The Idea of Marginal Utility
In the 19th century, economists came together to analyze the concept of price. The prevailing idea was that price affected utility. However, they were met with a paradox when they observed that certain nonessential items were priced much higher than essential items, for example, diamonds have a greater value than bread despite bread having more utility. This occurrence became known as the paradox of value, which was later solved by marginal utility. Because diamonds are rare, consumers are willing to pay more to obtain them, making their marginal utility higher than bread, which is less scarce.
Importance of Marginal Utility
Overall satisfaction with a product or service gauges future consumer decisions. For example, a snack manufacturer creates a new sandwich cookie featuring a flavor that has never been used before. The sandwich cookies are only distributed to test markets. After some time has passed, reviews of the product appear online showing that people love it. The remainder of the product leaves shelves fast as consumers buy multiple units at a time. This proves to the manufacturer that positive marginal utility has occurred, and they can expand their market range.
The Law of Diminishing Marginal Utility
Because of its success, the manufacturer makes deals with more vendors, allowing the product to be sold nationwide. However, that success is mitigated by the law of diminishing marginal utility. Developed by economists, this law states that over time, marginal utility decreases with each unit obtained by a consumer. Assuming all other variables related to a product remain the same, consumers eventually move on, similar to a fad.
The concept of marginal utility sprouted from the minds of 19th-century economists who were attempting to explain the economic reality of price, which they believed was driven by a product’s utility. However, this led to a conundrum known as the “the paradox of water and diamonds,” which is attributed to “The Wealth of Nations” author Adam Smith, which states that water has far less value than diamonds, even though water is vital to human life. Since marginal utility and marginal cost are used to determine price, this is paradoxical because the marginal cost of water is much lower than that of diamonds.
Key Points
- Marginal utility quantifies the added satisfaction a consumer garners from consuming additional units of goods or services.
- The concept of marginal utility is used by economists to determine how much of an item consumers are willing to purchase.
- Positive marginal utility occurs when the consumption of an additional item increases the total utility, while negative marginal utility occurs when the consumption of an additional item decreases the total utility.
- The concept of marginal utility sprouted from the minds of 19th-century economists who were attempting to explain the economic reality of price, which they believed was driven by a product’s utility.
- There are multiple kinds of marginal utility. Three of the most common ones are as follows:
- Zero marginal utility is when having more of an item brings no extra measure of satisfaction. For example, if you receive two copies of the same issue of a magazine, that extra copy has little added value.
- Positive marginal utility is when buying extra versions of an item is satisfying. One such example would be a store promotion where customers can walk out with a free pair of shoes if they buy two pairs upfront.
- Negative marginal utility is where too much of an item is actually detrimental. For example, while the correct dose of antibiotics can kill harmful bacteria, too much can harm a person’s body.
Marginal Utility Formula
The utility can be seen as the value a customer puts on a particular good or service. In simple terms, it can be defined as how much an individual is willing to pay for a good. For example, an art collector notices on social media that the work of one of his favorite artists is at an auction. The collector races to the auction, ready to write a check. Although the starting bid is $800, he immediately bids $5,000 to ensure his acquisition of the piece. Because the piece grants him a great deal of satisfaction, he places more worth or value on it.
In economics, the standard rule is that marginal utility is equal to the total utility change divided by the change in the number of goods. The formula appears as follows:
Marginal Utility = total utility difference / quantity of goods difference
- Find the total utility of the first event
- Find the total utility of the second event
- Find the difference between both (or all) events
- Find the difference between the number of goods between both (or all) events
How To Apply The Marginal Utility Formula
- Find the total utility of the first event: Finding marginal utility involves a comparison between two or more events to find an average. If the events involve placing a value on purchase prices, add each price together to find the first event’s total utility.
- Find the total utility of the second event: Consider information gathered from the second event. Determine the number of items changed as well as the proposed purchase price. Add all purchases together to find the second event’s total utility.
- Find the difference between both (or all) events: Collect the totals from both or all events and find their difference. The resulting answer becomes the total utility difference for the formula.
- Find the difference between the number of goods between both (or all) events: Add together all of the purchased items from the first event and find a total. Next, gather together all of the purchased items from the second (and any consecutive) events. Subtract the totals from each other and reach a solution.
- Apply the formula: With both final differences found, apply the information to the formula. Divide both differences and set them equal to marginal utility.
Example calculation for Marginal Utility
During her lunch break, Dr. Avasarala heads to a nearby food truck selling tacos. Each taco only costs $2 each, but Dr. Avasarala is so hungry, she’s willing to pay $5 each. Even though the tacos are only worth two dollars each, she places a utility worth $5.
During her stay at the truck, she wants to eat two tacos. Knowing she’ll be almost full after the first taco, she’s only willing to pay $3 for the second taco, placing a lower utility upon it. To find her total utility, she adds both totals together:
Total utility = 5 + 3
Total utility = 8
Dr. Avasarala places $8 worth of total utility on the two tacos.
On a separate visit to the food truck, Dr. Avasarala decides she’s willing to eat 5 tacos. After paying $5 for the first taco, she decides the second taco is only worth $4 because she’s filling up. After the second taco, she would only pay $1 each for the remaining 3 tacos. To find her total utility in the second visit, she adds all purchases together:
Total utility = 5 + 4 + 1 + 1 + 1
Total utility = 12
Dr. Avasarala places $12 worth of total utility on the five tacos.
To find marginal utility, she finds the difference between both visits.
Total utility difference = 12 – 8
Total utility difference = 4
Next, Dr. Avasarala subtracts the number of tacos from each visit from each other:
Quantity of goods difference = 5 – 2
Quantity of goods difference = 3
Dr. Avasarala has a difference of 3 tacos.
With this information in hand, Dr. Avasarala applies the formula:
Marginal utility = 4 / 3
Marginal utility = ~1.3 = 1.4
Dr. Avasarala finds she places a marginal utility of around $1.40 on each taco.