7.1.

1 definition and calculation of total utility and marginal utility

Let’s break down the concept of utility in economics step by step.

Step 1: What is Utility?

Utility is a fundamental concept in economics that represents the satisfaction or happiness a person
derives from consuming a good or service. In simple terms, it measures how much someone values and
enjoys what they consume.

Step 2: Types of Utility:

There are two main types of utility:

Total Utility (TU): This is the total satisfaction or happiness obtained from consuming a certain quantity
of a good or service. It considers the combined utility from consuming all units of the good.

Marginal Utility (MU): Marginal utility refers to the additional satisfaction or happiness gained from
consuming one more unit of a good or service. It focuses on the change in utility as you consume one
more unit.

Step 3: Calculation of Total Utility (TU):

Total Utility is calculated by summing up the utility obtained from consuming each unit of a good or
service. The formula for Total Utility is:

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For example, if you derive 10 units of satisfaction from consuming the first hamburger, 8 units from the
second, and 5 units from the third, your Total Utility for three hamburgers would be MU = (24 – 20) / (3 –
2) = 4

Step 4: Calculation of Marginal Utility (MU):

Marginal Utility is the change in Total Utility when you consume one more unit of a good. The formula
for Marginal Utility is: MU=ΔTU/ΔQ

Where:

MU is the Marginal Utility Δ

ΔTU is the change in Total Utility.

ΔQ is the change in the quantity consumed

For example, if your Total Utility for two cups of coffee is 20 and your Total Utility for three cups of coffee
is 24, then the Marginal Utility of the third cup of coffee would be

MU (24 – 20) / (3-2) = 4

Diminishing Marginal Utility:

Step 1: What is Marginal Utility?

Marginal utility is like the extra satisfaction you get from having one more of something, like eating one
more slice of pizza or buying one more video game.

Step 2: Diminishing Marginal Utility Explained:

The idea is that as you keep having more of that thing, like more pizza slices or more video games, the
extra satisfaction from each additional one tends to decrease.

So, the first slice of pizza might make you really happy, but by the fifth slice, you might not enjoy it as
much.

Equi-Marginal Principle:

Step 1: What is the Equi-Marginal Principle?

Imagine you have limited money to spend, and you want to buy different things, like pizza, video games,
and ice cream.

The Equi-Marginal Principle helps you decide how to spend your money in the best way to maximize
your overall happiness.

Step 2: Equi-Marginal Principle Explained:

It suggests that you should spend your money in such a way that the last dollar you spend on each item
gives you the same amount of extra happiness.

In other words, you should allocate your money so that the “bang for your buck” is equal for each item.

If buying one more slice of pizza gives you the same happiness as buying one more video game or one
more scoop of ice cream, then you’re following the Equi-Marginal Principle.

So, in simple terms, the Diminishing Marginal Utility tells us that we get less extra happiness as we
consume more of something, while the Equi-Marginal Principle advises us to spend our money in a way
that gives us the same extra happiness for each item we buy. This helps us make choices that make us as
happy as possible with our limited resources.
Step 1: What is an Individual Demand Curve?
An individual demand curve shows how much of a good or service a single person is willing to buy at
different prices.

Step 2: How to Derive an Individual Demand Curve:

Imagine you’re looking at how much ice cream a person named Alex is willing to buy at different prices.
Here are the steps:

Step 3: Collect Data

First, we need data. We ask Alex how much ice cream they’d buy at different prices. Let’s say we have
this data:

At $1 per scoop, Alex wants 5 scoops.

At $2 per scoop, Alex wants 4 scoops.

At $3 per scoop, Alex wants 3 scoops.

At $4 per scoop, Alex wants 2 scoops.

At $5 per scoop, Alex wants 1 scoop.

Step 6: Interpretation

This curve tells us that as the price of ice cream goes down, Alex is willing to buy more. When it’s
cheaper, Alex wants more ice cream, and when it’s more expensive, Alex buys less.

That’s how you derive an individual demand curve! It shows how much a specific person is willing to buy
at different prices. Remember, when prices change, individual demand curves can shift, giving us insights
into how consumers respond to price changes.

Here's a simplified text-based representation

5 Y (Quantity)

| .

| .

| .

| .

| .

0 +----------------------------- x (price)

$1 $2 $3 $4 $5
In this representation:

On the horizontal axis (X-axis), we have the price of ice cream ranging from $1 to $5.

On the vertical axis (Y-axis), we have the quantity of ice cream Alex is willing to buy, from 0 to 5 scoops.

The dots and line show how Alex’s demand changes with different prices. As the price decreases, the
quantity demanded increases, forming a downward-sloping demand curve.

Limitations of Marginal Utility Theory:

Assumption of Rational Behavior: The Marginal Utility Theory assumes that individuals always
make rational decisions to maximize their utility. In reality, people might not always act rationally. Human
behavior can be influenced by emotions, social pressures, and cognitive biases, leading to choices that
don’t align perfectly with utility maximization.

Measurement Challenges: Assigning numerical values to utility can be challenging because it is

subjective and varies from person to person. Utility is not directly measurable, and in practice, it's
impossible to quantify the precise level of satisfaction or happiness derived from consuming goods and
services.

Ignoring Non-Monetary Factors: The theory primarily focuses on monetary considerations and
assumes that utility depends solely on the quantity of goods consumed and their prices. It doesn’t
account for non-monetary factors that can significantly impact decisions, such as health, environmental
concerns, or social preferences.

Diminishing Marginal Utility Assumption: While the theory assumes diminishing marginal
utility, there are cases where this doesn’t hold true. Some goods, like addictive substances or
collectibles, may not exhibit diminishing marginal utility because people may desire more even at higher
quantities.

No Consideration of Interdependence: Marginal Utility Theory often treats individuals as isolated

decision-makers. It doesn’t consider the interdependence of people’s choices in markets, where the
actions of one consumer can influence the prices and availability of goods for others.

Assumptions of Rational Behavior in Marginal Utility Theory:

Complete Information: The theory assumes that individuals have complete and perfect
information about the goods and services available in the market. In reality, information is often
incomplete, asymmetric, or imperfect.

Consistency: Rational individuals are expected to make consistent choices based on their
preferences. However, people can exhibit inconsistencies and may change their preferences over time.
Utility Maximization: The core assumption is that individuals aim to maximize their utility
when making choices. This assumes that people have clear and stable preferences, which may not
always be the case.

No Externalities: The theory assumes that the choices of one individual do not affect the well-being
of others (no externalities). In reality, many decisions have spillover effects on society, like pollution or
resource depletion.

It's important to recognize these limitations and assumptions while idealized

representation of real-world decision-making, and real-world markets often
exhibit complexities and deviations from these assumptions.