Download THE RULE OF MARGINAL UTILITY Definitions: Total Utility – The

THE RULE OF MARGINAL UTILITY
Definitions: Total Utility – The total satisfaction from the consumption of a certain
amount of a given product, ceteris paribus.
Marginal Utility – The extra utility obtained from consuming one additional unit of a
commodity, ceteris paribus. The slope of the Total Utility function = ∆TUX/∆qx
Law of Diminishing Marginal Utility – As the consumer obtains additional quantities of a
given commodity per unit of time, ceteris paribus, the total utility function increases at a
decreasing rate. This means that the marginal utility function continuously decreases.
See graphs below:
MUX
MUX
TUX
TUX
qx
MUX
qx
MUX
Let’s look at this from a table:
qx
1
2
3
4
TUX
10
16
19
19
MUX
10
6
3
0
Now, the consumer’s idea is not to maximize the total utility from a given product. The
idea is to select a package of goods and services that will maximize the total utility out of
one’s income.
Let’s assume two products, X and Y. Then, the total amount of a good that income will
allow the consumer to purchase is:
Income (I) = PXqx + Pyqy
Think of it, if I = 10, PX = 2, and PY = 1; how much of X can the consumer buy if qy = 0?
You can purchase 10/2 = 5 units of X. If qx = 0; you can purchase 10/1 = 10 units of Y.
This trading ratio of 2X for 1Y is constant between the two goods.
Let’s try another table now for the two goods:
qx
1
2
3
4
5
6
TUX
25
45
60
70
75
75
MUX
25
20
15
10
5
0
MUX/PX
5
4
3
2
1
0
qy
1
2
3
4
5
6
TUX
14
20
24
26
26
26
MUX
14
6
4
2
0
0
MUY/PY
7
3
2
1
0
0
20 = 5qx + 2qy. Where would the consumer spend his/her marginal dollars? To find that,
we have to divide each MU by the product’s price. Now, where will this consumer spend
her/his money?
Dividing MU by price gives us the extra utility we gain by spending one more dollar on a
particular good. The MUY/2 for the first unit of Y is 7. The MUX/5 for the first unit of X
is 5. Therefore, this person will spend the first two dollars on Y, even though the total
utility for the first unit of X is greater than the total utility for the first unit of Y. The next
$5 will be spent on X for similar reasons.