How do we calculate marginal utility

 Introduction to Marginal Utility

Marginal utility is an important concept in economics as it tells us the amount of satisfaction which people will get on additional unit consumption of unit or a service. Both consumers and producers care about marginal utility. Consumers want to get the most satisfaction for their money. Producers want to price and supply enough units to maximize profits without wasting resources on excess unused inventory.

This concept of measuring additional utility on the margin guides good economic decisions:

For consumers - They will purchase more units until the product no longer brings enough extra satisfaction compared to the price. Understanding when marginal utility starts falling helps manage budgets.

For businesses - They may lower the price per unit for higher volumes, since customers gain less marginal utility from excess units anyway. Production volumes are also set based on optimal marginal utility.

How to calculate marginal utility?

Marginal Utility is defined as change in total utility per units of products consumed. For understanding this I will tell a simple concept, if I am thirsty and drink water first time, its utility or importance for me will be very high like 100 . But if I drink the water second time after drinking first time, then its utility will be lesser for me because I have drunk it once before and its enjoyment will be lesser so lets assume 80 in second time. So, marginal utility here tells the utility I get from last unit of water consumed. Usually the utility decreases when the number of unit consumed is more as in the case of water.

So, marginal utility for our water= Change in total utility/Change in units

Total utility = 100 (first time drink) + 80 (Second time) = 180

Change in total utility when I drink second time = 180(total) - 100( First time) = 80

So marginal utility = 80/ 1(change in unit)= 80

Calculation of Marginal Utility

Marginal utility is calculated by dividing the change in total utility by the change in quantity of units consumed. Mathematically

Marginal Utility = Change in Total Utility / Change in Number of Units Consumed =   Δ TU/ Δ Q where

Δ TU is change in marginal utility and Δ Q is change in quantity of unit consumed.

For example - consuming 1 unit of a good provides 80 utils (a measure of satisfaction), while 2 units provide 150 utils. Here:

Change in Total Utility = 150 utils - 80 utils = 70 utils

Change in Units Consumed = 2 units - 1 unit = 1 unit

Marginal Utility = 70 utils (change in total utility) / 1 unit (change in quantity) = 70 utils

Real life examples of marginal utility

1. Consumption of Snacks:

   • Scenario: Initially, the enjoyment of the first handful of potato chips is high.
   • Formula: $��=\frac{\mathrm{\Delta }��}{\mathrm{\Delta }�}$
   • Calculation: If the total utility ($��$) after the first handful is 20 and the quantity consumed ($�$) is 1, then $��=\frac{20}{1}=20$.
   • As you consume more, $��$ will decrease.

2. Reading a Book:

   • Scenario: The enjoyment of each chapter diminishes with continued reading.
   • Formula: $��=\frac{\mathrm{\Delta }��}{\mathrm{\Delta }�}$
   • Calculation: If the total utility ($��$) after the first chapter is 30 and the quantity ($�$) is 1, then $��=\frac{30}{1}=30$.
   • As you read more chapters, $��$ will decrease.

3. Buying Clothing:

   • Scenario: Each additional pair of jeans provides less satisfaction.
   • Formula: $��=\frac{\mathrm{\Delta }��}{\mathrm{\Delta }�}$
   • Calculation: If the total utility ($��$) after buying the first pair is 25 and the quantity ($�$) is 1, then $��=\frac{25}{1}=25$.
   • As you buy more, $��$ will decrease.

Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that as a consumer consumes additional units of a good or service, the additional satisfaction or utility derived from each successive unit decreases, assuming all other factors remain constant.

Explanation:

Satiation of Wants: The law is grounded in the idea that as a consumer continues to consume a particular good or service, the satisfaction derived from each additional unit diminishes. This is due to the fact that consumers have finite wants and needs, and as these are satisfied, the importance of each additional unit decreases.

Trade-offs and Preferences: The law also reflects the inherent trade-offs individuals make when allocating their resources. As more units of a good are consumed, the consumer must allocate resources that could be used for other goods or services. The diminishing marginal utility helps individuals make rational decisions based on their preferences and the available resources.

Resource Allocation: The law has implications for resource allocation in both consumption and production. In consumption, individuals will continue to consume units of a good until the marginal utility equals the price they are willing to pay. In production, firms must consider the diminishing marginal utility when determining the optimal quantity to produce.

Factors Affecting Marginal Utility

There are several factors that determine whether marginal utility is increasing, decreasing or negative as more units are consumed:

Scarcity - Goods that are scarce tend to have increasing marginal utility since they are highly valued. The more scarce they become, the bigger utility we derive from additional units.

Satisfaction of need - As we start satiating a particular need or want, marginal utility declines as additional units matter less. For example - additional food when already full.

Capacity to consume - Our own physical capacity limits how many units will continue satisfying. Having a 12th cupcake is less utility than the delicious 1st.

Time - Marginal utility can decrease if consuming too much of an item too quickly, like seeing several movies back-to-back.

Importance of Marginal Utility

There are crucial applications of analyzing marginal utility for both consumers looking to maximize benefit as well as producers aiming to optimize strategies:

Consumer purchase decisions - Consumers purchase up until marginal utility starts diminishing relative to the price paid. Understanding the point where an extra unit adds less satisfaction helps balance purchases and budgets.

Pricing - Firms may consider lowering prices on extra units understanding declining marginal utility limits what consumers will pay at higher volumes. Volume discounts use this principle.

Production volumes - Judging the point when utility starts falling guides how much of a good firms choose to produce and supply to the market.

Conclusion

In essence, marginal utility helps both consumers and producers evaluate additional consumption and production volumes relative to overall total utility. Factoring in marginal utility leads to decisions that aim toward economically efficient and maximized satisfaction levels given limited resources. Evaluating trade-offs at an incremental unit level through the lens of marginal utility provides meaningful insight for rational decision making.