Marginal Utility – Meaning, Importance, Factors, Types, and Graph

What is Marginal Utility?

Marginal Utility (or MU) is a concept in economics. It is a measure of additional satisfaction or benefits that a user gets from consuming one extra unit of a commodity or a service. Economists primarily use this concept to determine how many units a user could purchase of a particular item.

MU isn’t constant; it can be positive, negative, or zero. MU is positive when the consumption of additional units increases the total utility. And MU is negative when consuming additional units reduces the overall utility.

Usually, the MU for a consumer drops as they consume more units of that commodity. We call such a phenomenon the diminishing marginal utility.

A point to note is that utility and marginal utility are two different terms. The former reflects the total level of satisfaction that a user gets after consuming a specific amount of a commodity or service. And MU tells about the extra satisfaction that a user gets after consuming one more unit of a commodity.

Importance of Marginal Utility

MU also helps to explain how consumers make choices to gain maximum from the money they have. Usually, a consumer would continue to consume more of a commodity as long as the MU is more than the marginal cost. In an efficient market, the price of a commodity or service is the same as the marginal cost. This is the reason why consumers will continue to buy until their MU drops or equals to the price of the commodity or service.

Thus, knowing MU could prove extremely helpful for companies as it would give them an idea of the effectiveness of their products/services in satisfying the demand of a user. This, in turn, assists management in determining the chances of a user re-buying their product or service.

Companies can use this information to design their strategies for the existing set of customers. Also, it guides them on the efforts they need to put in so that a user gets the same level of satisfaction after every purchase. In short, we can say that MU can help companies retain customers.

It won’t be wrong to say that along with helping companies to study customer behavior or consumer equilibrium. MU also helps in identifying market trends and determining product prices.

Factors Affecting Marginal Utility

There are many factors that impact the utility, but the two most important ones are time and first use.

By time here, we mean the time when a user consumes a product or service. For example, if you prefer having a coffee in the morning, then its MU will be less if you drink a coffee in the evening. Similarly, when you are alone, you could read books. But when your friends are around, you may not feel the need to read books. This means that a product or service available at the right time offers more satisfaction.

Talking about the first use factor, the first unit you consume is more likely to give you more satisfaction than the remaining units. For instance, when you are hungry, the first unit of food, say a burger is likely to give more happiness than the next consecutive unit.

Types of Marginal Utility

Three most common types of MU are:

Positive MU

When a user gets more happiness by consuming an additional unit of the same commodity, it means positive MU. For instance, if you love eating pizza and the second slice gives you more happiness than the first, it will result in a positive MU.

Zero MU

This means that consuming an additional unit doesn’t bring more or less, but rather the same level of happiness or satisfaction. Taking the above example, if after the second slice, your stomach starts to fill, then the third slice will likely give you the same level of satisfaction as the second. The MU, in this case, will be zero.  

Negative MU

If the happiness or satisfaction a user gets after consuming an additional unit is less than the previous unit, then it is negative MU. In the pizza example above, the fourth slice may give less satisfaction than the third because you are no more hungry. This would result in a negative MU.  

Formula and Example of Marginal Utility

Below is the most popular formula to calculate the MU:

Marginal Utility = Change in Total Utility/ Change in no. of units

Let’s take an example to understand the calculation of MU.

Suppose Mr. A goes to a restaurant to have a burger. Though the burger costs $3, Mr. A is so hungry that he is ready to pay $5 for it. So, the utility of the burger will be $5. Mr. A eats two burgers, but for the second burger, Mr. A is ready to pay $4 as he isn’t that much hungry anymore. Thus, the utility cost drops.

Total utility for Mr. A in this visit will be $9 ($5 plus $4).

Mr. A visits the same restaurant again after a few days. This time, however, he is even more, hungrier and decides to eat four burgers. Mr. A is ready to pay $6 for the first and $5 for the second. But after the first two burgers, Mr. A isn’t hungrier, thus can pay only $2 each for the last two burgers.

The total utility for Mr. A in this visit will be $15 ($6 plus $5 plus $2 plus $2).

Change in total utility between the two visits = $15 less $9 = $6

Change in the no. of units between the two visits = 4 less 2 = 2

So, MU will be = 6/2 = 3

Real-World Applications of MU

The following are the most popular application of MU:

Progressive Taxation System

Such a taxation system means that those with higher incomes should pay more in taxes than those with lower incomes. In contrast, a flat tax rate system is disadvantageous to those with low income because the marginal cost will be more than the MU. Thus, we can say that MU justifies the progressive taxation system.

Consumer Behavior

We now know that consumers will buy the products that give them more MU. Thus, companies can use this information to work on ways to enhance a user’s MU with their products or service.

Pricing of Goods

Companies can also use MU for pricing their goods. For example, a restaurant sells two burgers, A and B. From the sales data, the restaurant found that most customers order 2 units of B and one unit of A. This could mean that MU for 2 units of B is the same for most customers. Using this information, the restaurant adds an option to get 2 units of B together. This allowed the company to reduce its packing costs and serve more customers.

Product Innovation

Manufacturers come up with innovations to ensure the marginal utility of a consumer doesn’t go down. For example, if a car model performs well, then the automaker usually update that model for a few years, i.e., add new innovative features, to ensure consumer keep loving it. Adding more features also justifies the rise in prices. We can also say that MU helps with customer retention as well.

Sanjay Borad

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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