Marginal Utility analysis helps us understand the behavior of a consumer by looking at the way he spends his income on different goods and services to attain maximum satisfaction. In this article, we will look at the assumptions, laws, and limitations under marginal utility analysis.
Browse more Topics under Theory Of Consumer Behavior
Marginal Utility Analysis
Before we begin, let’s understand the meaning of two important terms – total utility and marginal utility
- Total Utility or Full Satiety – is the sum of utility derived from different units of a commodity consumed by a consumer. Therefore, Total Utility = the sum total of all marginal utility.
- Marginal Utility or Marginal Satiety – is the additional utility derived from the consumption of an additional unit of a commodity. Therefore, Marginal Utility = the addition made to the Total Utility by consuming one more unit of a commodity.
Assumptions of Marginal Utility Analysis
1] The Cardinal Measurability of Utility
This theory states that utility is a cardinal concept. In other words, it is measurable and quantifiable. Hence, you can say that you derive a utility of 10 units from consuming 1 unit of commodity A and 5 from consuming 1 unit of commodity B. This can help you compare different commodities and analyze which commodity offers better utility or satisfaction.
The theory further states that money is the measuring rod of utility. So, the amount of money that you are willing to spend for a unit of commodity rather than going without it is the measure of utility that you derive from the said commodity.
2] The constancy of the Marginal Utility of Money
The second assumption is that when you are spending money on a commodity, the marginal utility of money remains constant throughout. This facilitates the measurement of the utility of commodities in terms of money.
3] The Hypothesis of Independent Utility
This theory ignores the complementarity between goods. It states that the total utility that you get from a collection of goods is a simple sum total of the separate utilities of each good.
The Law of Diminishing Marginal Utility
This is an important law under Marginal Utility Analysis. Alfred Marshall, British Economist defines the law of diminishing marginal utility as follows:
“The additional benefit which a person derives from a given increase in the stock of a thing diminishes with every increase in the stock that he already has.”
This law is based on the fundamental tendency of human nature. Human wants are virtually unlimited. However, every single want is satiable. Hence, as we consume more and more units of a good, the intensity of our want for the good decreases. Eventually, it reaches a point where we no longer want it.
In other words, as we consume more units of a good, the extra satisfaction that we derive from the extra unit keeps falling. However, it is important to remember that the marginal utility declines NOT the total utility.
Let us see an example. The table below presents the total and marginal utility derived by Peter from consuming cups of tea per day.
|Quantity of Teas||Total Utility||Marginal Utility|
As seen in the table above, when Peter consumes one cup of tea in a day, he derives a total utility of 30 utils (unit of utility) and a marginal utility of 30 utils. When he takes two cups per day, the total utility rises to 50 utils but the marginal utility falls to 20. This trend continues until the last row where the marginal utility is negative. This means that if Peter consumes 11 or more cups of tea per day, then he might fall sick. Here is a graph representing the table:
Relationship between Total and Marginal utility
- As the total utility rises, the marginal utility diminishes
- When the total utility is maximum, the marginal utility is zero.
- As the total utility starts diminishing, the marginal utility becomes negative.
This law helps us understand how a consumer reaches equilibrium in case of a single commodity. Typically, a consumer utilizes a commodity until its marginal utility becomes equal to the market price. This ensures that he derives maximum satisfaction by being in equilibrium in respect of the quantity of the commodity.
In case of a fall in the price of the commodity, the equality between marginal utility and price gets disturbed. Therefore, the consumer will consume more units of the good leading to a fall in the marginal utility. He continues consuming until the equilibrium is achieved. On the other hand, in case of a rise in the price of the commodity, he will consume less and achieve equilibrium too.
Limitations of the Law
The law of diminishing marginal utility applies only under certain assumptions:
- Homogeneous units – The different units of a commodity are identical in all respects. The income, taste, temperament, habit, etc. of the consumer also remains unchanged.
- Standard units of consumption – The units of consumption consist of standard units. If a man is thirsty, then water should be given in units of a glass. If you give him a spoonful of water, then the second spoon would conceivably have higher utility than the first.
- Continuous consumption – There is a continuous consumption of units. That is, there is no gap between the consumption of two units.
- Not applicable to prestigious goods – The law does not apply to prestigious goods like gold, cash, etc. where a greater quantity can increase the lust for it.
- Related goods – If you don’t have sugar, then you will consume less tea. Hence, the utility of goods can be affected by the absence of related goods.
Solved Question on
Q: Total utility declines with every increasing unit. True or False?
Ans; The following statement is False. The total utility does not decline with every increasing unit. The marginal utility will decline with every increasing unit.