Total And Marginal Utility
Utility is the satisfaction that a person derives from the consumption of a good or service. Total utility is the total satisfaction received from consuming a given total quantity of a good or service, while marginal utility is the satisfaction gained from consuming another quantity of a good or service. Sometimes, economists like to subdivide utility into individual units that they call utils. However, because utility is subjective, meaning that it differs from person to person, and because it varies continuously, depending on the quantity consumed, an util cannot actually be measured, but is simply a heuristic device that allows economists to talk about the degree of satisfaction of a product or service.
Although one definition of utility is usefulness, usefulness is not a quality in economic utility. For instance, water is very useful, but doesn't have much utility for most people. On the other hand, judging by recent gold prices in the market, gold has great utility for some people, but it is not very useful.
One quality of marginal utility is that it always declines for each successive quantity consumed of a particular good. If you like ice cream, and you eat one scoop, the first scoop will provide the greatest satisfaction. If you eat another scoop, you'll probably enjoy that also, but the satisfaction will be less than for the first. At some point, you will not want any more ice cream. The marginal utility will drop to zero and will even become negative. This is an everyday illustration of the law of diminishing marginal utility. Marginal utility declines for everything, including money. Although many people want to amass great wealth, each dollar that is accumulated becomes worth less and less, because the marginal utility of what it can buy declines.
Declining marginal utility explains why the demand curve slopes downward as the supply quantity is increased, and why people will only consume more if the price declines, since people's willingness to pay also declines.
Marginal utility can also be related to the elasticity of demand. If demand is inelastic, then the quantity demanded drops off sharply as the price increases; with elastic demand, quantity drops off more slowly. So a product for which there is inelastic demand will have a marginal utility that drops off sharply, while a product with elastic demand will have a marginal utility that declines more slowly.
Consumer choice is guided by preferences for specific products, budget constraints, prices, and the marginal utility of products. A budget constraint exists because the consumer only has so much money, so he can only spend so much; therefore, even among things that he desires, he must still make a choice. This choice will depend on the marginal utility of the product and its price. Because marginal utility declines with quantity, while the price does not vary, a consumer will tend to buy as much product until the marginal utility of the product falls below the marginal utility of other products that the consumer can buy. Hence, the consumer stops buying more of a product when the marginal utility of an additional amount is less than its price. In this way, the total utility of what the consumer can purchase within his budget is maximized. So the marginal utility of each type of product divided by its price will be roughly equal to the marginal utility of the other products that the consumer purchased divided by their prices.
|Marginal Utility of Product A|
Price of Product A
|=||Marginal Utility of Product B|
Price of Product B
Indifference Curve Analysis
How consumer choice varies with marginal utility is sometimes depicted with indifference curves. Each point on an indifference curve represents a combination of products that yields the same total utility for the consumer. Because each consumer's purchasing power is limited, this budget constraint, represented by a budget line, limits the choices that the consumer can actually make.
Indifference curve analysis is simplified by assuming that the consumer spends all of her money on 2 products. For instance, suppose the consumer has $12 to spend on cantaloupes and apples. Each cantaloupe costs $2 apiece and each apple costs $1 apiece. The following table shows what can be purchased:
This yields the following budget line:
An indifference curve for this example would yield every combination of apples and cantaloupes that yield the same total utility. Indifference curves are convex to the origin because of the law of diminishing marginal utility — when there is a predominance of cantaloupes, then the marginal utility of an additional cantaloupe is less than the marginal utility of an additional apple, and vice versa. In other words, consumers like variety. A tangent line to an indifference curve represents the marginal rate of substitution (MRS) of one product for the other that maintains total utility.
An indifference map can be created by several indifference curves representing an increased budget for apples and cantaloupes that allows the consumer to buy more of each product for a greater total utility. Generally, consumers with higher incomes will have larger budgets for specific items. In the above diagram, for instance, I1 represents the indifference curve at the lowest total utility of the 3 displayed in the diagram. The consumer would not choose any point on this curve because her higher income with her correspondingly increased budget for cantaloupes and apples would allow her to achieve greater total utility by choosing a point on indifference curve I2 that would still be affordable. When the consumer's budget line is superimposed on the indifference map, the point where the budget line is tangent to the highest indifference curve is the highest attainable total utility, given the consumer's budget, and represents the consumer's equilibrium position. Although curve I3 offers higher utility, the price of any combination of cantaloupes and apples on this indifference curve is outside of her budget.