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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.