Principles of Economics/Marginal Utility

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Average versus Marginal[edit]

The margin is the edge of a situation; marginal is the adjective form. If a firm is currently producing 10 units of a good, the tenth and eleventh are both considered marginal units of production. Generally, the marginal costs and benefits of a good are more important in determining whether we do something than the average; we would like more of something if its marginal benefits outweigh its marginal costs (e.g. where one likes another unit of a good more than the unit of money one has to expend for it). Even if the average happiness from each individual good obtained may decrease from consuming another unit of goods at the margin, one would still consume it because its value itself, its marginal value, is still positive and greater than the marginal cost.

Utility and Marginal Utility[edit]

Utility is the amount of happiness brought by a certain amount of a good for the individual. Marginal utility/Marginal benefit is the amount of happiness brought by the next unit of a good. Under ideal circumstances, the marginal utility of the next unit is infinitely less than the amount of happiness brought by the previous unit of a good. A more precise definition would involve calculus, but a preferred way of "fudging" this relationship involves taking the average of the next and previous units' marginal utilities:

Marginal utility =

where

  • is the marginal utility of the previous unit
  • is the marginal utility of the next unit

Law of Diminishing Returns[edit]

The Law of diminishing returns states that as more and more of a good is produced/consumed, the less marginal benefit the next unit of that good brings. Goods generally start with high marginal returns at low levels of the good, lower marginal returns at higher levels of the good, and negative marginal returns at even higher levels of the good.

This is generally the case with food; as one consumes more and more food, one begins to lose taste for even more food; at one point, one becomes indifferent for whether one wants to eat more; at even higher levels of the food, one feels too full and may be worse off.

[See if you can make a graph that represents/models this law.]