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Diminishing Marginal Utility Explained

Consumers seek to maximize their utility subject to budget constraints. The equi-marginal principle states that consumers will allocate their budget in a way such that the marginal utility per dollar spent is equal across all goods. Diminishing marginal utility implies that as consumption of a good increases, the additional satisfaction from each additional unit decreases. While useful, marginal utility theory makes simplifying assumptions about rational behavior that do not always reflect real-world consumer decision making which can be influenced by non-utility factors such as psychology.

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15 views2 pages

Diminishing Marginal Utility Explained

Consumers seek to maximize their utility subject to budget constraints. The equi-marginal principle states that consumers will allocate their budget in a way such that the marginal utility per dollar spent is equal across all goods. Diminishing marginal utility implies that as consumption of a good increases, the additional satisfaction from each additional unit decreases. While useful, marginal utility theory makes simplifying assumptions about rational behavior that do not always reflect real-world consumer decision making which can be influenced by non-utility factors such as psychology.

Uploaded by

Starrie Line
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

30.

1
Utility
the satisfaction recieved from consumption
Utility assumes that satisfaction can be measured in units, similar to goods consumed.
Example: buying another slice of pizza for less the price

Law of diminishing marginal utility


As consumption increases, the satisfaction from consumption decreases.

Ways to measure of satisfaction


Total Utility
The total satisfaction received from consumption.

Marginal Utility
The Utility derived from the consumption of one more unit of the good or service.

30.2 THE EQUI-MARGINAL PRINCIPLE


Equi-marginal principle
Consumers maximize their Utility where their marginal valuation for each product consumed is
the same

Equi-marginal principle is based on assumptions that


● consumers have limited incomes
● behave rationally
● seek to maximize utility.

illustration
In Table 30.2, two products (x and y) priced at $1 and $2, with a consumer having $10 to spend.
Equilibrium Criteria: Consumer equilibrium occurs when the marginal utility per dollar spent
(MU/P) is the same for each product.
Optimal Consumption: In the example, 4x and 3y are consumed, providing the highest total
utility of 235. Any other combination yields less satisfaction.

30.3 Derivation of an individual demand curve


Marginal utility can be used to explain an individual's demand curve.
● In Table 30.2, consider a price reduction for product y to $1 while x's price and income
remain unchanged.
● New Equilibrium: Recalculate MU/P for y, resulting in a new equilibrium of 4x and 6y,
representing a gain of 3y.
● Total Utility Increase: The changes lead to an increase in total utility, showcasing the
impact of altered prices on consumer equilibrium.
● A portion of the demand curve is visually depicted to represent the relationship between
marginal utility, price changes, and consumer equilibrium.

30.4 Limitations of marginal utility theory and assumptions of rational behaviour


Assumptions of Marginal Utility Theory:
● Rank Ordering: Assumes consumers can rank their wants and assign values to the
satisfaction gained from consumption.
● Rational Behavior: Assumes consumers act rationally in their purchasing decisions.
Law of Diminishing Marginal Utility:
● Assumption: Assumes that as consumption of a good increases, the additional
satisfaction (marginal utility) derived from each additional unit decreases.
● Rational Decision-Making: Implies that consumers make rational decisions in allocating
their resources to maximize utility.
Real-World Evidence:
● Other Factors: Real-world evidence consistently shows factors beyond utility influence
purchasing decisions.
● Behavioral Factors: Understanding behavioral factors involves considering psychological
influences and being aware of people's thoughts and motivations.

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