Marginal utility is a measure that defines the additional satisfaction a customer receives from one more unit of a product or service. It helps companies determine 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 consumers’ future purchasing decisions. 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 never forget the law of diminishing marginal utility. According to this law, the utility of a product decreases with every consumption of a product’s additional unit. Because of this, you can also see that customers are ready to pay less for each extra unit, which means that they become less satisfied with every additional consumption.
Marginal utility is leveraged in progressive taxation systems. Companies use it to analyze customer behavior, identify market trends, and decide on product prices and innovations.
Now that the importance of marginal utility is evident, let’s walk you through the types of this measure.
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. Let’s review each type in more detail to see how customer happiness affects it.
- Positive marginal utility. You can see this type of marginal utility when an additional item brings happiness to a customer. Say, there’s a person who loves to eat cakes, so when they eat an extra slice, they 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, they 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 their health. Say, if a person ate two slices of an apple pie, they could feel sick after the third one.
Time to move to the calculations.
How to calculate marginal utility
Companies and individuals widely use marginal utility calculations to give a qualifiable worth to their products and services. With its help, they gauge the success of a particular item and adjust their production. Although some companies leverage complex 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 learn how to find the necessary measures.
- Find the first total utility. To find an average measure, a manager needs to determine the total utility of a customer’s 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 the 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. Afterward, subtract the totals from each other to get the second measure — quantity of goods difference.
To understand where to start, let’s look at our example first.
Marginal utility example
Let’s imagine that there’s a very hungry office worker who decided to go to a cafe with veggie burgers on its menu. Although one veggie burger costs only $3, this visitor can even pay $6 for each. Therefore, the utility worth of one burger will be $6.
During their stay in the cafe, the worker is eager to eat two burgers. Since this person already knows that they will be full after the first veggie burger, they are 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 later, the worker wants to eat four burgers. After paying $6 for the first veggie burger, they decide that the second burger is only worth $5 because they don’t feel so hungry anymore. After they eat the second one, they 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.
Hence, 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 their marginal utility.
- This article defines the term and 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: 04.11.2021