Utility

The Concept of Utility

Utility refers to the satisfaction or happiness a consumer derives from consuming a good or service. It is a subjective measure and varies from person to person. Economists typically assume that utility is ordinal, meaning that the numerical values assigned to utility levels reflect the consumer's preferences, rather than having an absolute meaning.

There are different ways to measure utility, including verbal scales, hedonic scales, and cardinal scales. However, the ordinal approach is most commonly used in economics.

Total Utility and Marginal Utility

Total Utility (TU) is the overall satisfaction a consumer gains from consuming a certain quantity of a good or service.

Marginal Utility (MU) is the additional satisfaction gained from consuming one more unit of a good or service. It represents the change in total utility resulting from a one-unit change in consumption.

$$MU = \frac{\Delta TU}{\Delta Q}$$

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that as a person consumes more and more units of a good or service, the additional satisfaction gained from each additional unit will eventually decrease. This is a fundamental principle in economics and explains many consumer behavior patterns.

This law is not absolute; it simply suggests that the rate of decrease in marginal utility may slow down or even temporarily reverse, but it generally holds true in the short run.

The Equi-Marginal Principle

The Equi-Marginal Principle is a key concept in consumer decision-making. It states that consumers maximize their overall satisfaction by allocating their income in such a way that the marginal utility per pound spent is equal across all goods and services.

In simpler terms, consumers should spend their money on goods and services until the additional satisfaction they get from buying one more unit of a good is equal to the additional cost of buying that unit.

This principle assumes that consumers are rational and aim to maximize their utility given their budget constraints.

Illustrative Example

Consider a consumer with a budget of £100 and who can choose between apples and bananas. Let's assume the following marginal utilities:

Good	Quantity	Total Utility	Marginal Utility	Price	Marginal Utility per Pound
Apples	1	10	10	£2	£5
Apples	2	18	8	£4	£2
Apples	3	24	6	£6	£1
Bananas	1	8	8	£1	£8
Bananas	2	14	6	£2	£3
Bananas	3	16	2	£3	£0.67

In this example, the consumer would maximize their utility by allocating their £100 budget to apples and bananas in a way that the marginal utility per pound spent is equal for both goods. This would likely involve buying 2 apples and 1 banana.

The equi-marginal principle helps explain consumer choices and is a cornerstone of microeconomic theory.

Limitations of the Equi-Marginal Principle

While a powerful concept, the equi-marginal principle has some limitations:

• Perfect Information: It assumes consumers have perfect information about prices and marginal utilities, which is rarely the case in reality.
• Rationality: It assumes consumers are perfectly rational and always act to maximize their utility.
• Addiction and Habit: The principle may not fully explain behavior driven by addiction or habit, where marginal utility may not diminish predictably.