Loading the player...

What is 'Marginal Utility'

Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important economic concept because economists use it to determine how much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases the total utility. Negative marginal utility is when the consumption of an additional item decreases the total utility.

BREAKING DOWN 'Marginal Utility'

Economists use the concept of marginal utility to measure happiness and pleasure, and how that affects consumer decision making. They have also identified the law of diminishing marginal utility, which means that the first unit of consumption of a good or service has more utility than the next units of consumption.

Example of Marginal Utility

The following example can demonstrate the concept of marginal utility. Imagine that a person has four bottles of water and purchases a fifth bottle of water. Next, imagine that a second person has 50 bottles of water and purchases one more bottle of water. The first person buying the fifth bottle of water will get far more utility from that fifth bottle of water because of its proportion to the total. This fifth bottle increases the total water by 25%. The second person gains far less utility from purchasing a 51st bottle of water, precisely because its proportion to the total is so low. This 51st bottle of water increases the total water by only 2%. As a person purchases more and more of a product, the marginal utility to the buyer gets lower and lower, until it reaches a point where the buyer has zero need for any additional units of the good or service. At that point, the marginal utility of the next unit equals zero.

The idea of marginal utility resulted from 19th-century economists attempting to explain the economic reality of price, which they believed was driven by a product's utility. This, however, led to a paradox that is commonly known as the "the paradox of water and diamonds," which is attributed to Adam Smith, author of The Wealth of Nations. The paradox states that water has a value far less than diamonds, even though water is vital to human life and diamonds aren't. Since marginal utility and marginal cost are used to determine price, the paradox is that the marginal cost of water is much lower than that of diamonds.

RELATED TERMS
  1. Total Utility

    The aggregate level of satisfaction or fulfillment that a consumer ...
  2. Utility

    1. An economic term referring to the total satisfaction received ...
  3. Law Of Diminishing Marginal Utility

    The Law Of Diminishing Marginal Utility is a law of economics ...
  4. Utilities Sector

    A category of stocks for utilities such as gas and power. The ...
  5. Marginal Benefit

    The additional satisfaction or utility that a person receives ...
  6. Utility Revenue Bond

    A type of municipal bond that is issued to finance utility projects, ...
Related Articles
  1. Insights

    Explaining Marginal Utility

    Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service.
  2. Investing

    Water: The Ultimate Commodity

    Opportunities to invest in this scarce resource are flowing freely - dive in!
  3. Insights

    Trust In Utilities

    Even in times of economic turmoil, utilities can be a good investment.
  4. Investing

    Are Safe Haven Utility Stocks, ETFs Too Expensive?

    With so many investors seeking safety are utility stocks and ETFs a crowded trade?
  5. Investing

    The Economic Effects of Water Shortages

    Raising water prices to dampen demand is a necessary approach to solving the world's water shortage.
  6. Investing

    The Debt Report: The Utilities Sector

    Discover how blue chip U.S. utilities companies are using debt, and why it was important for the industry to deleverage after the financial crisis.
  7. Financial Advisor

    Why Utility Stocks Are No Longer a Safe Haven

    Utility stocks have been the best performing sector in the S&P 500 Index so far this year but many believe they are now overvalued.
  8. Investing

    The Top 5 Utility ETFs for 2016 (XLU, IDU)

    Discover the top utility company ETFs, and learn more about how you can get exposure to water, electricity and natural gas utility companies.
  9. Investing

    Risks to Consider When Investing in Water

    Investing in water should be a lock. But water is volatile and could see as many risks as potential rewards.
RELATED FAQS
  1. What is the difference between marginal utility and marginal value?

    Find out what marginal utility and marginal value mean in economics and why these terms sometimes overlap to describe the ... Read Answer >>
  2. What does marginal utility tell us about consumer choice?

    Learn how marginal utility influences consumer choice under the law of diminishing marginal utility and consumer decisions ... Read Answer >>
  3. How do businesses calculate their marginal utility?

    See why, even though businesses do not have marginal utility of their own, a firm can apply the concept of diminishing marginal ... Read Answer >>
  4. What is the difference between marginal utility and marginal benefit?

    Learn more about the different interpretations, uses, and implications of marginal benefit and marginal utility in economic ... Read Answer >>
  5. How do economists and psychologists calculate diminishing marginal utility differently?

    Find out why disagreements about the validity of the law of diminishing marginal utility usually boil down to arguments about ... Read Answer >>
  6. What is "marginalism" in microeconomics and why is it important?

    Find out what economists mean by marginal utility or cost and why marginalism is such an important concept in microeconomic ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center