In this video we’ll learn about the law of diminishing marginal utility and its relationship
to the demand curve.
By the end of the video you’ll be able to explain the law of diminishing marginal utility
and also identify the link between diminishing marginal utility and the individual and market
demand curve.
What is meant by the term utility?
In economics, utility represents the satisfaction gained from the consumption of a good or service.
In the next slide we’ll look at how and why utility diminishes, or reduces as we consume
more of a particular good.
The law of diminishing marginal utility states that as an individual consumes more of a good
or service, ceteris paribus, their utility will decrease with each additional unit.
The common example that I use in class is pizza.
Whenever I order pizza I know that when the doorbell rings and the pizza is delivered,
I am about to consume as much as I can.
The first slice is always the best one for me.
The consumption of the first slice brings me a utility of 9 on a 1 to 10 scale.
The second slice brings me a lot of utility, about 8.
By the third slice I’m starting to get so full that my utility drops to 5.
By the fourth slice, I’m full and that slice brings me a utility of 2.
If I continue to the fifth slice after I’m full, then I may experience zero or negative
utility.
In this example, I’ll say I stopped after the fourth slice.
Let’s examine the data again and break down the relationship between utility and the demand
curve.
The column with all the smiley faces is actually a measure of marginal utility.
Marginal utility corresponds to the additional utility gained from consuming the next unit.
My overall utility is increasing, but my marginal utility that is associated with each successive
unit is decreasing.
Let’s plot this information on a diagram, with marginal utility on the Y axis and the
quantity of slices of pizza on the X axis.
For the Y axis we’ll include the numbers 1 to 9 as the peak utility was 9.
For the X axis we’ll include the numbers 1 to 5 as my overall consumption was less
than 5 slices.
For the first slice, I had a marginal utility of 9.
The second slice, 8.
The third slice, 6 and the fourth and final slice 2.
Remember, I didn’t consume a fifth slice.
What you will notice is that I have a high level of marginal utility for that first slice
- mostly because I’ve gone from not having anything to eat to finally eating something.
As I consume more and more slices, my marginal utility diminishes, or reduces.
If I was willing to pay $1 for each unit of utility, I’d be willing to pay up to $9
for the first slice, $8 for the second slice, $6 for the third slice and $2 for the fourth
slice.
As you can imagine, if the equilibrium price of a pizza slice was $9, I’d probably only
end up eating one slice.
That’s because the second slice will only bring me a utility of 8, and I’m only willing
to spend $9 on 9 units of utility or above.
If that price dropped to $8 a slice, I’d be willing to buy 2.
As long as the value of the marginal utility is greater than or equal to the expense I
face, I’m willing to consume an additional unit.
I could continue to consume until my marginal utility is equal to the amount I’d be willing
to pay.
If pizza slices cost $2, I’d eat four slices.
Even if they cost $1, I would still stop at four slices.
Remember, after the fourth slice, my utility drops to zero or below.
Let’s use that same information to convert the marginal utility graph into a demand curve.
We switch out marginal utility for price and leave the Y-axis unchanged.
At higher prices, you’ll see the quantity demanded is low and as the price drops, there
is a greater quantity demanded.
We could expand this example by measuring the overall utility gained by consumers in
a market and plot a similar curve reflecting all of their utility, and indirectly, demand.
If we sum all of the individual demand curves in this market, we arrive at our market demand
curve.
If the utility is constant amongst all consumers, then this is the likely outcome.
However, it is highly unlikely all consumers receive the same level of utility from pizza
and it is hard to measure a unit of utility regardless.
So while we can establish somewhat of a relationship between marginal utility, individual demand
curves and market demand curves, we must always remember that utility in an of itself is generally
a subjective measure which can vary greatly from individual to individual.
By now you should be able to explain the law of diminishing marginal utility and also identify
the link between diminishing marginal utility and the individual and market demand curve.
If you have any questions or comments you can leave them below, or email me at enhancetuition@gmail.com.
Visit me online at www.enhancetuition.co.uk and check out the additional resources I’ve
posted.
That’s us done for now and I will see you in the next one!