Marginal Utility

What is the marginal principle?

The concept that economic agents operate on the next unit of output (focusing on the next unit rather than the next 100 units as a whole). This allows them to focus on the next small unit when making decisions. This is based on the fact that economic agents will act rationally - if the marginal benefit of a particular action exceeds the marginal cost we should proceed.

What is the concept of Marginal utility?

The change in total utility as a result of consuming the next unit of the good or service.

What is the Law of Diminishing marginal utility?

As the number of units consumed increases, the utility derived from each additional unit of consumption decreases.

As you consume more, the marginal utility decreases. The total utility still increases but at a slower rate.

Marginal utility curve

What is the Equi marginal principle? (use when evaluating rationality)

Marginal utility of X / Marginal utility of Y

=

Price of X / Price of Y

Why does the Equi marginal principle not explain the price of all goods and services we consume?

• You cannot quantify utility and it is subjective for each person

  • utility will be different for each individual

• The principle relies on people acting rationally but this might not be the case due to:

  • Inertia - the reluctance to change

  • Loss aversion - they don’t like taking risks

  • Emotions and Impulses