Marginal Utility – Definition and How to Calculate
Marginal Utility supports both economists and individuals to put a quantifiable sense of worth on goods. Businesses use marginal Utility to define the success of a product or service and adjust production as needed.
Large corporations use complex calculations, but the can be found with a simple formula. In this article, we explain what marginal Utility is and how to calculate it with an example.
What Is Marginal Utility?
Marginal Utility is the added comfort that a consumer gets from having one more unit of a good or service. The concept of marginal Utility is done by economists to determine how much of an item consumers are willing to buy.
Positive marginal Utility occurs when the consumption of an additional item boosts the total Utility. On the other hand, negative marginal Utility happens when the consumption of one more unit decreases the overall Utility.
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 higher than essential things.
For example, diamonds have a more excellent value than bread despite bread having more Utility. This occurrence became known as the paradox of value, which was later solved Because diamonds are rare, consumers are willing to pay more to obtain them, making their marginal Utility higher than bread, which is less scarce.
Why is Marginal Utility Important?
Overall fulfilment 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 work leaves shelves fast as consumers buy multiple units at a time. This proves to the manufacturer that positive has happened, and they can expand their market range.
The Law of Diminishing Marginal Utility
Because of its success, the manufacturer deals with more vendors, allowing the product to be sold nationwide. However, that victory is mitigated by the law of diminishing marginal utility. Developed by economists, this law states that marginal Utility decreases with each unit obtained by a consumer over time. Assuming all other variables related to a product endure the same, consumers ultimately move on, similar to a fad.
How to Calculate Marginal Utility
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 one of his favorite artists’ work is at an auction. The collector races to the sale, ready to write a check.
Although the starting bid is $800, he immediately bids $5,000 to ensure his piece’s acquisition. Because the piece grants him a big deal of satisfaction, he places more worth or value on it. In economics, the standard rule is that is equal to the total utility change divided by the difference in the number of goods. The formula appears as follows:
Marginal utility = total utility difference/number 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 variance between the number of goods between both (or all) events
- Apply the formula
Find the total Utility of the first event: Finding marginal Utility involves comparing two or more events to find an average. If the events involve placing a value on purchase prices, add each price to see 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 advanced purchase price.
- Add all purchases together to find the second event’s total Utility.
Find the variance between both (or all) events: Assemble the totals from both or all events and find their difference. The resulting answer becomes the real utility difference for the formula.
Find the difference between the number of goods between (and 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 last differences found, apply the information to the formula. Divide both differences and set them equal to marginal Utility.
In our study, we have so far concentrated on the marginal utility of a good and argued that for goods, the law of diminishing holds: the more units we consume, the less our wellbeing increases.