Marginal Utility

Definition

Marginal utility is the additional satisfaction or value a consumer derives from consuming one more unit of a good or service. It represents the change in total utility as the consumption of a product increases by one unit.

5 Must Know Facts For Your Next Test

1. Marginal utility plays a crucial role in how individuals make choices based on their budget constraint, as consumers aim to maximize their total utility given their limited resources.
2. Consumers make consumption choices by comparing the marginal utility of different goods and services to determine which combination will provide the greatest overall satisfaction.
3. Changes in income and prices affect consumption choices by altering the marginal utility of goods, leading consumers to adjust their spending patterns to maximize utility.
4. Government policies to reduce income inequality, such as progressive taxation and income redistribution, can influence the marginal utility of income and affect consumption choices.
5. The law of diminishing marginal utility explains why consumers generally derive less satisfaction from each additional unit of a good as they consume more of it.

Review Questions

• Explain how marginal utility influences an individual's choices based on their budget constraint.
  • Individuals make choices based on their budget constraint by comparing the marginal utility of different goods and services. They will allocate their limited resources to purchase the combination of goods that provides the greatest total utility. Marginal utility plays a key role in this decision-making process, as consumers will continue to buy a good until the marginal utility of that good is equal to the marginal utility of the next best alternative, given their budget constraint.
• Describe how changes in income and prices affect consumption choices through the lens of marginal utility.
  • Changes in income and prices affect consumption choices by altering the marginal utility of goods and services. When income increases, consumers can afford to purchase more of the goods they desire, leading to a decrease in the marginal utility of those goods. Conversely, when prices increase, the marginal utility of a good relative to its cost decreases, causing consumers to substitute towards goods with higher marginal utility per dollar spent. These changes in marginal utility drive consumers to adjust their spending patterns to maximize their overall utility given the new budget constraints.
• Analyze how government policies to reduce income inequality can influence the marginal utility of income and affect consumption choices.
  • Government policies aimed at reducing income inequality, such as progressive taxation and income redistribution, can impact the marginal utility of income for both low-income and high-income individuals. For low-income individuals, an increase in disposable income can lead to a higher marginal utility of that income, as it can be used to purchase more essential goods and services. Conversely, for high-income individuals, a decrease in disposable income due to higher taxes can result in a lower marginal utility of that income, as they have already satisfied their basic needs. These changes in the marginal utility of income can then influence the consumption choices of individuals across the income spectrum, as they seek to maximize their overall utility given the new constraints.

Related terms

Total Utility: The overall satisfaction or value a consumer derives from consuming a good or service.

Law of Diminishing Marginal Utility: The principle that as a consumer consumes more of a good, the additional satisfaction or value they derive from each additional unit decreases.

Opportunity Cost: The value of the next best alternative forgone when making a choice.