Understanding Utility & the Equi-Marginal Principle (Cambridge (CIE) A Level Economics): Revision Note

Utility theory

• Utility is the satisfaction gained from consumption 

  • Marginal utility is the additional utility (satisfaction) gained from the consumption of an additional product

• The utility gained from consuming the first unit is usually higher than the utility gained from consuming the next unit

  • For example, a hungry consumer gains high utility from eating their first hamburger. They are still hungry and purchase a second hamburger but gain less satisfaction from eating it than they did from the first hamburger

• To calculate total utility, the marginal utility of each unit consumed is added together

  • This means that total utility keeps increasing even while marginal utility is decreasing

• The Law of Diminishing Marginal Utility states that as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit

• A consumer achieves utility maximisation when they spend their limited income in such a way that they will achieve the most satisfaction from their money

Diminishing marginal utility

• The law of diminishing marginal utility states that as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit

• The law of diminishing marginal utility helps to explain why the demand curve is downward sloping

  • When the first unit is purchased, the utility is high and consumers are willing to pay a high price

  • When subsequent units are purchased, each one offers less utility and the willingness of the consumer to pay the initial price decreases

  • Lowering the price makes it a more attractive proposition for the consumer to keep consuming additional units

  • This is one reason why firms offer discounts such as '50% off the second item' 

• A consumer achieves utility maximisation when they spend their limited income in such a way that they will achieve the most satisfaction from their money

• When marginal utility is zero, total utility is maximised

The equi-marginal principle

• The equi-marginal principle helps explain how a rational consumer allocates their limited budget to gain the most utility

  from their spending

• A person is in consumer equilibrium when they cannot rearrange their spending to gain more total enjoyment

• In economic terms, this happens when:

• 

• Where

  • MU = marginal utility (extra satisfaction from one more unit)

  • P = price of the product

  • a and b are different products