I go over what Marginal Utility is in economics.

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Transcript:

What is marginal utility?

Marginal utility is an economics buzzword that has great importance for understanding the incentives in human action.

Economist Carl Menger of the Austrian School introduced this concept in his 1871 book, “Principles of Economics.”

He argued that the subjective value of a good is, in part, determined by marginal utility, that is, the extra satisfaction gained by consuming one more unit of that good.

To help you understand, let’s think of an example with microwaves.

For most people, having a microwave is fairly useful.

You can heat up food and drinks, and the speed at which microwave ovens work is far faster than conventional gas or electric ovens.

If you’re living alone, a single microwave will usually suffice for your needs.

If you have a big family, having 2 microwaves might be nice in case two people need to use one at the same time.

Or, maybe, you’re a cook who likes to make multiple items at once to serve guests, and 2 microwaves make it so that the food all comes out hot at once.

For many, having 3 microwaves would seem like a waste because, realistically, needing to use 3 microwaves at the same time isn’t likely.

If you had 4 microwaves, you’d probably be annoyed because you’d have no place to put them, and the unneeded microwaves would be taking up space somewhere in your closet, garage or attic.

If you had 100 microwaves, you’d probably be frustrated as you couldn’t even get into your house because the floor would be covered in microwaves.

While the 100 microwaves example seems a little silly, it provides an important point that people have a limit to how many of an item they’d want before their desire for that item goes down to zero.

The marginal utility, or subjective usefulness of each additional item, starts to dwindle drastically after one’s core wants and needs are met.

And these wants and needs are subjective.

While many people may only want one microwave, there are those who have large homes with multiple kitchens with a need for multiple microwaves.

There are some who want to buy multiple microwaves because they remodel homes and so need multiple microwaves to install in their reno projects.

There are some who like to be able to heat multiple items at once, and so like having two microwaves side-by-side.

There are some who might buy multiple microwaves for the purpose of resale.

Whatever subjective value it is, it is different across individuals and whether any person will value having a second, or third, or fourth microwave will depend on each person’s specific wants and needs.

This is also why freedom in market choice is so important.

As each person knows his or her own wants and needs best, it is important that each person can choose for themselves the goods and services that they need based on what they can afford.

A central planner who decides that everyone only needs one microwave misses out that each person has unique needs and desires, whether it is someone using multiple microwaves as they train to become a chef, or a large family who needs multiple microwaves so that all 8 of their children can have their dinner ready at the same time.

Central planners cannot account for all individual wants and needs as they shift in time, and they especially cannot factor the marginal utility of each person’s desire for an additional good.

Prices enable individuals to meter their marginal utility comparisons.

For example, a person may be initially looking to buy 3 bananas.

However, when they see a buy 4, get 2 free sign for bananas, they may consider buying the additional banana because, upon seeing the sign, they realize they would have enough bananas to make 2 smoothies instead of just one at a better price.

The price incentive causes the buyer to consider the utility of having more bananas and, in doing so, causes them to consider that having 3 more bananas would be enough to make a second smoothie, which would bring more subjective value.

The buyer may also recognize that if they try to buy more than 6 bananas, those additional bananas will go bad before they get consumed, making them undesirable.

In this example, the marginal utility of holding ripe bananas ends at 6 as the purchaser has no use for the bananas at the time of purchase beyond the 6.

While some have tried to quantify marginal utility as a formula, the truth is that marginal utility is both subjective and in constant fluctuation depending on changing life circumstances.

For another example, if the banana purchaser only wanted 6 bananas, but they suddenly got a call from a friend who wants to come over and have a smoothie as well, the purchaser may now want more bananas because they want to buy them for their friend so that their friend can have a smoothie too.

As you can see, wants and needs are constantly changing depending on life circumstances.

As economic thinkers, it’s just a matter of recognizing that key consumption decisions are best left to individuals so they can accommodate their wants and needs based on what is offered in the market.

Any deviation from freedom to choose means that people are stuck not getting their wants and needs met in an efficient and ethical manner.

Sources

1. The Law of Marginal Utility

https://mises.org/online-book/human-action/chapter-vii-action-within-world/1-law-marginal-utility

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