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 illustrates the concept of marginal utility. Consider 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 percent. 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 percent. 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. Utilities Sector

    The utilities sector encompasses stocks from electric, gas, water ...
  2. Utility

    Utility is an economic term referring to the total satisfaction ...
  3. Produced Water

    Waste water generated during the production of oil and natural ...
  4. Water Quality Improvement Act Of ...

    Legislation that expanded the federal government's authority ...
  5. Marginalism

    Marginalism covers the study of marginal theories and relationships ...
  6. Utility Revenue Bond

    A utility revenue bond is a debt security which is designed to ...
Related Articles
  1. Investing

    Bottled Water: ‘Marketing Trick of the Century’

    Bottled water surpassed soda as the largest U.S. beverage category last year—thank advertising.
  2. Investing

    Water: The ultimate commodity

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

    Top 3 ETFs for Investing in Water in 2017

    It may be time to look at a scarce commodity that isn't getting the investor attention it deserves.
  4. Investing

    Opportunities In The Emerging Market's Water Crisis

    Water scarcity and increasing demand caused by population growth is one of the most compelling long-term portfolio themes.
  5. Investing

    Water-Related Investments Are Making A Splash

    There’s no doubt about it. The world is facing a water crisis. However, for forward thinking investors, that could mean a huge opportunity.
  6. Investing

    PepsiCo's New Water to be Introduced at Super Bowl

    "LIFEWTR" may help PepsiCo close the gap between itself and Coca-Cola in the bottled water market.
  7. Investing

    Global Water Resources Trades Ex-Dividend Thursday (GWRS)

    Global Water will send its dividend payment on Oct. 31 to shareholders of record as of Oct. 17.
  8. Investing

    Should Water Be Privatized?

    Could water privatization mean lower costs, greater efficiency and higher quality compared to public sector providers? A look at the evidence so far.
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. What does the law of diminishing marginal utility explain?

    Learn about some of the important economic insights that can be derived from applications of the law of diminishing marginal ... Read Answer >>
  4. 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 >>
  5. How many different types of utility stocks are there?

    Learn more about utility stocks and about some of the differences between different kinds of utility companies, including ... Read Answer >>
  6. What are the main factors that drive share prices in the utilities sector?

    Learn why the share prices of companies in the utility sector have sensitivity to interest rates and to changes in the amount ... Read Answer >>
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center