Marginal utility analysis focuses on understanding the consumer’s behaviour in allocating his expenditure on different goods and services for the maximum utilization of the available resources. To delve more into the topic, let us first understand the marginal utility analysis definition.
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What is Marginal Utility Analysis?
To understand the concept of the marginal utility analysis, we need to focus on the following two points.
Total utility refers to the sum of all the marginal utilities associated with different units of any commodity utilized by the consumer. Total utility is also known as full satiety.
Marginal utility refers to the utility related to any additional component of the commodity. Individual marginal utility contributes to the total utility.
Assumptions of Marginal Utility Analysis
There are certain assumptions of marginal utility analysis.
Marginal utility is considered to be a cardinal concept, i.e., it is quantifiable and measurable. If you derive different utilities from consuming variable units of separate commodities, then you can compare the commodities and select the one which provides better satisfaction and rate of utility. The theory also considers money as the means to measure utility. The utility derived from a given commodity is the amount spent on that commodity instead of going against it.
To facilitate marginal utility analysis on a particular commodity in the terms of money, it is important to assume that the marginal utility remains constant.
The independent utility hypothesis considers that the total utility is the sum of all the separate utilities of each commodity. It does not take into consideration the complementarity that exists between different commodities.
Diminishing Marginal Utility Law
The diminishing marginal utility law is an important law of marginal utility analysis. The British economist Alfred Marshall puts forward the diminishing marginal utility analysis definition as the additional profit, associated with an increase in the stock of a commodity, decreases with the increase. Such a law was based on the human nature of unlimited demands. As more and more units are consumed, the intensity of our desire decreases to a point when we no longer desire it. Therefore, the extra benefits associated with the consumption of surplus units of any product decreases as the consumption of the product increases. However, it must be kept in mind that although the marginal utility decreases with increasing stock, the total utility does not decrease.
Correlation Between Total Utility and Marginal Utility
If you have understood what is marginal utility analysis, then you will be able to denote the correlation between total utility and marginal utility. The following points will define such a relationship.
The total utility can rise although if the marginal utility decreases.
If the total utility has reached the maximum value, marginal utility is equal to zero.
If the total utility decreases, the marginal utility value tends to be negative.
Such a correlation helps in the understanding as to why a consumer can reach the equilibrium state for a single commodity. The consumer generally uses the commodity until its value matches the market price. This will enable the complete utilization of that product. In case of a decline in the commodity price, the consumer increases the consumption of that product to a point where the marginal value has declined to the equilibrium state. If the commodity price rises, the consumer will decrease the consumption so that the equilibrium is maintained.
Limitations of the Law of Diminishing Marginal Utility
There are certain limitations to the law. It is based on certain assumptions as follows.
Homogeneous Units: The different units of products and the attributes of the consumer like temperament, taste, income, etc. are identical at all times.
Standard Consumption Units: The consumption units are considered to be standard units. For example, the unit for water consumption will always be a glass.
Continuous Consumption: The consumers continuously consume the units of the product without any gap in between.
The Law cannot be applied to Prestigious Goods: The law does not take prestigious goods into consideration since the increase in stock increases the demands.
Related Goods: The utility of any product is related to the presence or absence of a related product. For example, your tea consumption can be less in the absence of sugar.