Marginal Utility Analysis

Marginal Utility Analysis

Marginal utility is an additional utility obtained from the consumption or use of an additional unit of a good. It can be put in other words as the change in total utility divided by the change in quantity. Marginal utility indicates an extra satisfaction from consuming an extra unit. Marginal utility needs to be contrasted with the related term total utility. Marginal utility is the additional amount of satisfaction obtained from consuming one additional unit of a good. Total utility is the overall amount of satisfaction obtained from consuming several units of a good. While the maximization of total utility represents the ultimate goal of consumption, the analysis of consumer behaviour gives greater emphasis on the marginal utility.
As consumer proceeds with his consumption total utility increases as more of a good is consumed, but the marginal utility decreases with the consumption of each additional unit. The decrease in marginal utility with an increase in the consumption of a good reflects law of diminishing marginal utility.

The Law of Diminishing Marginal Utility: Marshillian Approach

Marginal utility refers to the change in satisfaction which results when a little more or little less of that good is consumed.
The law of diminishing marginal utility says that with the increase in the consumption of a good there is a decrease in the marginal utility that person derives from consuming each additional unit of that product.

Law of Equi-marginal Utility

The Law of Equi-Marginal Utility is an extension to the law of diminishing marginal utility. The principle of equi-marginal utility explains the behavior of a consumer in distributing his limited income among various goods and services. This law states that how a consumer allocates his money income between various goods so as to obtain maximum satisfaction.

Law of Demand

The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.

Derivation of Demand Curve

The law of demand can be derived directly from the law of diminishing marginal utility. The marginal utility declines as more units of a commodity are consumed. The consumer will go on purchasing more units of a commodity until the marginal utility¬†becomes equal to the market price of the commodity. The condition of equilibrium when only one good is purchased is: “Marginal Utility is equal to market price”. If marginal utility of a good is measured in terms of money then the marginal utility curve becomes the demand curve of the good. If the market price is P1, the consumer buys Q1 units of this good.

Shift in Demand Curve

The shift of a demand curve takes place when there is a change in the relationship between quantity and price that is brought about by a change in any of the factors influencing demand except price. A demand shift results in a new demand curve.
When income rises, the demand curve for inferior goods shifts left, while the demand curve for normal goods shifts right. When the price of a good rises, the demand curve for substitute goods shifts right; while the demand curve for complementary goods shifts left because there is more demand for the substitute goods than complementary goods.

Causes of Shift in Demand

Changes in disposable income
Changes in taste and fashion (changes in preferences)
The availability and cost of credit
Changes in the prices of related goods (substitutes and complements)
Population size and composition
Change in education level
Change in the geographical situation of buyers
Change in climate or weather