Utility and marginal utility
Why do people buy what they buy? Consumer theory models choices as people trying to get the most satisfaction from limited budgets.
Utility
Utility is the satisfaction or benefit a person gets from consuming goods and services. It cannot be measured directly, but economists use it as a way to describe preferences: if you choose A over B, A gives you more utility. Total utility is the satisfaction from all units consumed.
Marginal utility
Marginal utility is the extra satisfaction from consuming one more unit. The first slice of pizza when hungry gives high marginal utility; the fifth gives much less. This pattern is called diminishing marginal utility, and it is central to explaining why demand curves slope downward.
The diamond-water paradox
Water is essential for life but cheap; diamonds are inessential but expensive. Marginal utility resolves the paradox: water is so plentiful that the marginal unit has little value, while diamonds are scarce, so the marginal diamond is highly valued. Prices reflect marginal, not total, utility.
The utility-maximising rule
With a limited budget, a consumer maximises utility by spending so that the marginal utility per dollar is equal across goods: MU of good X / price of X = MU of good Y / price of Y. If the last dollar on X gives more satisfaction than the last on Y, shift spending toward X.
Worked example
Coffee costs 4 dollars and gives 20 units of marginal utility; a muffin costs 2 dollars and gives 16. Coffee gives 5 per dollar; the muffin gives 8 per dollar. The consumer should buy more muffins and less coffee until the ratios equalise, as diminishing marginal utility lowers the muffin's extra benefit.
Deriving demand
If the price of muffins rises, their marginal utility per dollar falls, so the consumer buys fewer until the ratios balance again. This gives the downward-sloping demand curve from individual choices. Adding up all consumers' quantities at each price gives market demand.
Consumer surplus revisited
Each unit you buy is worth your marginal utility to you; you pay the market price for every unit. The difference on the units before the last is consumer surplus. Diminishing marginal utility means early units give the biggest surplus.
Limits of the model
The model assumes people know their preferences and calculate carefully. In practice, choices are shaped by habits, advertising, social influence, and limited attention. Behavioural economics studies these deviations, covered later in this unit.
Key takeaways
Utility is satisfaction from consumption; marginal utility is the extra from one more unit and usually diminishes. Prices reflect marginal, not total, utility, resolving the diamond-water paradox. Consumers maximise utility by equalising marginal utility per dollar across goods. This logic produces downward-sloping demand curves.
Flashcard
Satisfaction from consumption
Check your understanding
A consumer gets 30 units of marginal utility from a 3-dollar sandwich and 12 from a 2-dollar drink. To raise total utility, she should: