Marginal Analysis and Marginal Utility
8/13/2019 Jacob Reed
Economists like to say “decisions are made at the margin.” In economics the term “margin” means degree of difference at the edge. So when economists say decisions are made at the margin, that means people make a series of small decisions based on a small degree of change.
1. What are total and marginal?
2. What is benefit maximizing behavior?
3. What is diminishing marginal utility?
This is a microeconomic concept that tells us the benefit (utility) gained by consuming more of a good or service decreases with each unit consumed. So if Jenny eats 1 cheeseburger, she might gain 100 utils (units of satisfaction), eating a second cheeseburger might be worth 50 utils to her, a third worth 10, and a fourth worth 1 util. While her total utility increases with each cheeseburger consumed (100, 150, 160, then 161), the marginal utility (additional benefit) decreases with each cheeseburger consumed.
4. How does marginal utility impact consumer behavior?
Marginal Utility per Dollar is a calculation of a value to price ratio for the consumption of an additional unit of a product. The formula is Marginal Utility divided by Price (MU/P). Using the cheeseburger example above, if each cheese burger costs $5, the Marginal utility per dollar for the second cheeseburger would be 10 utils per dollar (50/$5).
Utility Maximization occurs when a consumer adjusts their spending to maximize their total utility within their given income limitations. Utility maximization occurs when the marginal utility per dollar for all the goods you purchase are equal (MUx/Px=MUy/Py). To simplify, let’s assume Jenny only buys 2 different goods; cheeseburgers and soda. The 2 charts below show her the utility per dollar for both goods.
If Jenny has $20 to spend, she would maximize her utility by purchasing 4 sodas and 2 cheeseburgers. There, the marginal utility per dollar (MU/P) for cheeseburgers is 10 and the marginal utility per dollar for sodas is 10. That would give her a total utility of 280 utils. Given the fact she only has $20, she cannot get more utility than that. She has maximized her utility.
If Jenny’s current consumption was 6 sodas and 1 cheeseburger the marginal utililty per dollar for cheeseburgers (20) would be greater than the marginal utility per dollar for sodas (6). When the marginal utility per dollar for both goods is not equal, a consumer would increase total utility by consuming less of the item with a low marginal utility per dollar and more of the item with a high marginal utility per dollar. In other words, the consumer should buy more of the item giving her a better deal and less of the item giving her a worse deal.
**Note: you could see questions exactly like this where total benefit or marginal benefit are used instead of total utility or marginal utility. Since benefit and utility are essentially synonyms, you will answer the question exact same way.
This method of utility maximization is very similar to profit maximizing combinations and cost minimizing combinations of resources. Producers just calculate the marginal product per dollar or marginal revenue product per dollar for productive resources instead.
Multiple Choice Connections:
2012 Released AP Microeconomics Exam Questions: 49, 51
2008 Released AP Microeconomics Exam Questions: 5, 49
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