Marginal utility is a measure that defines an additional benefit a customer receives from one more unit of a product or service. It helps companies figure out the number of products a consumer is eager to buy and assess how satisfaction influences consumer decisions.
In this article, we’ll find out the importance of the metric, check out the types and examples, and get to know how to calculate marginal utility.
Why is the law of diminishing marginal utility important?
Knowing the marginal utility allows companies to be aware of customers’ satisfaction or happiness with a certain product. This is because the level of fulfillment shapes the future purchasing decisions of consumers. If the measure indicates a high level of satisfaction and product success among buyers, it means that people will continue buying from a brand. That’s why a company can consider making deals with more suppliers and reaching new locales.
A business owner should always remember the law of diminishing marginal utility. According to the law, the utility of a product decreases with every consumption of an additional unit of a product. Because of this, you can also see that consumers are ready to pay less for an extra unit. With every additional consumption, they become less satisfied.
The marginal utility is leveraged in a progressive taxation system. Companies use it to analyze customer behavior and identify market trends, decide on the prices of products and innovations.
So, now when the importance is clear, let’s walk you through the types of marginal utility.
Types of Marginal Utility
Consumer behavior and decisions are the two main things that influence the type of marginal utility you obtain as a result. So, now let’s review each type in more detail and how customer happiness affects it.
- Positive marginal utility. This type you can see when an additional item brings happiness to a customer. Say, there’s a person who loves to eat cakes, so when he eats an extra slice, he would enjoy it and get some positive emotions.
- Zero marginal utility. When this type occurs, it indicates that an additional product didn’t manage to bring some more satisfaction to a consumer. For example, when a person eats two hamburgers and feels full, he wouldn’t enjoy having a third one.
- Negative marginal utility. This indicates that if a customer consumes too much of a product, an extra portion might even harm his health. Say, if a person ate two slices of an apple pie, after the third one, he can feel sick.
Time to move to the calculations.
How to Calculate Marginal Utility
Marginal utility calculations are widely used by companies and individuals to give a qualifiable worth to their products and services. With its help, they gauge the success of a certain item and adjust production. Although some companies leverage difficult estimations to figure out the measure, you can calculate it by using a simple formula you see below.
Now let’s see the steps in detail to find out how to find the necessary measures.
- Find the first total utility. To find an average measure, the marginal utility requires a manager to find the total utility of the first visit. Total utility is the level of customer satisfaction from consuming a product or service. You need to sum up the prices a consumer is willing to pay for the first and each additional product to obtain the total utility.
- Search for the second total utility. Analyze the information you have about the second visit. Pay attention to the sum of money a customer is ready to pay for your products and use the same approach. Add all prices together to obtain the second total utility.
- Calculate the difference. Once you figure out the total utilities of the visits, collect them to calculate the difference. The result you obtain will be the measure you need to use in the formula.
- Estimate the difference between the number of goods. After obtaining totals, you need to sum up the purchased goods from the first visit. Do the same for the second visit. After, subtract the totals from each other to get the second measure — quantity of goods difference.
To understand where to start, let's look at an example first.
Marginal Utility Example
Let’s imagine that there’s a very hungry office worker who decided to go to the cafe with veggie burgers on its menu. Although one veggie burger costs only $3, this visitor can even pay $6 for each. So, the utility worth of one burger will be $6.
During his stay in the cafe, the worker is eager to eat two burgers. Since this person already knows that after the first veggie burger he will be already full, he is ready to pay $4 for the second one. As a result, the utility cost decreases. To find the total utility, we need to sum up the prices the worker is willing to pay.
Total utility (1) = $6 + $4 = $10.
During the second visit to the cafe a month after, the worker wants to eat four burgers. After paying $6 for the first veggie burger, he decides that the second burger is only worth $5 because he doesn’t feel so hungry anymore. After he eats the second one, he would only pay $2 for each next burger.
Total utility (2) = $6 + $5 + $2 + $2 + $2 = $17.
Let’s find the total utility difference = $17 - $10 = $7.
Quality of items difference = 5 - 2 = 3.
Now let’s estimate marginal utility.
Marginal utility = 7 / 3 = 2.3.
So, the marginal utility shows the level of satisfaction a customer can obtain from consuming an additional product or service. A consumer stops buying additional products when the price is higher than the marginal utility.
- This article defines the term, provides readers with types and examples.
- In this article, the author uncovers the characteristics of marginal utility.
- This article provides readers with information about the law of diminishing marginal utility.
Last Updated: 03.06.2021