Utility
We have already seen that the focus of economics is to understand the problem of scarcity the
problem of fulfilling the unlimited wants of humankind with limited and/or
scarce resources.
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Because of scarcity, economies need to allocate their
resources efficiently. Underlying the laws of demand and supply is the concept
of utility, which represents the advantage or fulfillment a person receives from
consuming a good or service. Utility, then, explains how individuals and
economies aim to gain optimal satisfaction in dealing with scarcity.
Utility is an abstract concept rather than a concrete, observable quantity.
The units to which we assign an �amount� of utility, therefore, are arbitrary,
representing a relative value. Total utility is the aggregate sum of
satisfaction or benefit that an individual gains from consuming a given amount
of goods or services in an economy. The amount of a person's total utility
corresponds to the person's level of consumption. Usually, the more the person
consumes, the larger his or her total
utility will be. Marginal
utility is the additional satisfaction, or amount of utility, gained from
each extra unit of consumption.
Although total utility usually increases as more of a good is consumed, marginal
utility usually decreases with each additional increase in the consumption of a
good. This decrease demonstrates the law of diminishing marginal utility.
Because there is a certain threshold of satisfaction, the consumer will no
longer receive the same pleasure from consumption once that threshold is
crossed. In other words, total utility will increase at a slower pace as an
individual increases the quantity consumed.
Take, for example, a chocolate bar. Let's say that after eating one chocolate
bar your sweet tooth has been satisfied. Your marginal utility (and total
utility) after eating one chocolate bar will be quite high. But if you eat more
chocolate bars, the pleasure of each additional chocolate bar will be less than
the pleasure you received from eating the one before - probably because you are
starting to feel full or you have had too many sweets for one day.
This table shows that total utility will increase at a much slower rate as
marginal utility diminishes with each additional bar. Notice how the first
chocolate bar gives a total utility of 70 but the next three chocolate bars
together increase total utility by only 18 additional units.
The law of diminishing marginal utility helps economists understand the law of
demand and the negative sloping demand curve. The less of something you have,
the more satisfaction you gain from each additional unit you consume; the
marginal utility you gain from that product is therefore higher, giving you a
higher willingness to pay more for it. Prices are lower at a higher quantity
demanded because your additional satisfaction diminishes as you demand more.
In order to determine what a consumer's utility and total utility are,
economists turn to consumer demand theory, which studies consumer behavior and
satisfaction. Economists assume the consumer is rational and will thus maximize
his or her total utility by purchasing a combination of different products
rather than more of one particular product. Thus, instead of spending all of
your money on three chocolate bars, which has a total utility of 85, you should
instead purchase the one chocolate bar, which has a utility of 70, and perhaps a
glass of milk, which has a utility of 50. This combination will give you a
maximized total utility of 120 but at the same cost as the three chocolate bars.
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