Marginal Utility and its relationship to Economics

Definition of 'Marginal Utility' from Investopedia

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.

In economics, the marginal utility of a good or service is the gain from an increase or loss from a decrease in the consumption of that good or service. Economists sometimes speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a good or service yields more utility than the second and subsequent units, with a continuing reduction for greater amounts.

When discussing the marginal utility of money Economists tend to use the term the law of marginal utility because the marginal utility of money always relates to the next marginal unit of money which may be more or be less than the previous marginal unit. Human behaviorists recognize that people tend to want more wealth, actually an ever increasing amount of wealth, thus the difference.

Investopedia explains 'Marginal Utility'

For example, if you were really thirsty you'd get a certain amount of satisfaction from a glass of water. This satisfaction would probably decrease with the second glass, and then decrease even more with the third glass. The additional amount of satisfaction that comes with each additional glass of water is marginal utility.

With money this does not necessarily follow as one can theoretically spend or invest an unlimited amount of money and gain satisfaction at every marginal unit received with more satisfaction gained if the marginal unit is greater than the last marginal unit, satisfaction is unchanged if the marginal unit is the same as the last marginal unit, or diminish if the next marginal unit is smaller than the last marginal unit.

Capitalist schools of Economics consider the anomaly exists only because of the desire for limitless wealth is human nature whereas with a good or service only so much can be consumed without losing satisfaction in the utility.

 

Well, if one accepts the premise (i.e. that "the desire for limitless wealth is human nature," then the conclusion is certainly irresistable (i.e. that any addition in wealth--no matter to what extent--is equally satisfying as any previous addition in wealth).

But I reject the fundamental premise.

For many of us, financial stability in the present and financial security for the future, coupled with a satisfying (middle-class) lifestyle is really all that matters. If I were suddenly to come into 100 million dollars, I simply cannot imagine how that might change--in any meaningful way--my day-to-day lifestyle.

 

The issue is really not about one person, like you, and I presume there are many like you. But the limitless desire for wealth: is a well established human behavioral trait. There are a number of Economists who use that trait as a way to understand why some people work so hard at accumulating money and assets well beyond any human need.

The basic idea that if your next pay check was larger than your last you would be pleased. It is as simple as that. If that is not the case you are definitely living outside of the mold. Most of us would like more, not necessarily huge fortunes Like Gates and Soros, or the Rockerfellas, but more.

 

I suppose it all depends upon the individuals involved.

Those toiling away in dead-end jobs (as opposed to fulfilling careers) probably would prefer to come into a great amount of money, so that they could use the famous Johnny Paycheck line ("Take this job and shove it!").

And those mired in poverty would, no doubt, like to be able to pay all the bills promptly, put food on the table, and have a reasonable amount of discretionary spending money, without having to make necessary tradeoffs.

I cannot explain, however, why anyone who is financially comfortable might wish to increase, significantly, his (or her) wealth. That is, unless it is for the purpose of putting on airs, and pretending that sudden riches make one inherently superior to others.

 

I think what Joachimr was saying about it "not being personal" tells us it is something about humanity and not something about any individual. When a economic issue is discussed based on examination of human behavior it is about the conglomerate, not the individual, yet when discussing marginal utility it is that part of the conglomerate boiled down to the one who is perceiving the satisfaction or lack thereof who is the determining factor. Many people, myself included look to wealth as being as much a problem from the standpoint of human behavior as those just getting by.

Man evolved from the hunter gatherer never knowing where his next meal would come from. This led "humanity" to seek limitless wealth to eliminate that problem and economists make understanding their bailiwick based on basic human behavior observations.

It is reasonable to assume that as individuals no one person will follow the mold completely, or that there is such a thing as "normal" though the "norm" can be calculated based on statistical analysis and it becomes a fixed point within any study group.

You might also consider that this point of view about marginal utility is based on capitalistic theory and does not necessarily follow from the point of view of the socialist school of economics.

If man had continued to be a hunter gatherer he would have had no reason to envy high achievers. But it is that envy of those who are high achievers by those who just get by which creates such obvious contentions.

 

Marginal utility varies with good or service considered.
If you are talking about bread, a loaf of bread is of value, if it feeds you, a second loaf allows you to entertain a guest at dinner or feed a family, each loaf has value, but less than the preceding loaf.
If a bread truck dumped a thousand loaves on your doorstep, the value becomes negative, as it will cost you to remove the bread that becomes stale and moldy.
So you may spend your first money on bread, but once you have a loaf, the next purchase might be butter. Which doesn't have as high a marginal value as the first loaf of bread, but may have a higher marginal value than the second loaf.
Gold, money, wealth, things that can be translated into any good or service, always have the marginal value of the good or service that has the highest current marginal value, so the curve of the marginal value of money declines less than any other.
But it still declines, consider the millionaire who uses a $100 bill to light a cigar.
$100 may have been a substantial sum for him once, but today he can substitute it for a match, well that, and the satisfaction of a little ostentatious behavior.
He still desires to have more wealth, but obviously not another $100, he considers more wealth to be that which comes in bigger chunks, like another million dollars.
And then we have the example of men like Bill Gates, Warren Buffet, Andrew Carnegie, who at some point want less wealth, they desire to disperse their wealth into the community in support of what they consider worthwhile social goals.

 

Yes!

Correct!

Positively! Once the marginal unit becomes greater than the immediate need of a commodity or service the marginal utility of that good or service diminishes.

Basically, the curve will have a different slope depending on the size of the marginal unit.

All very true, but don't forget when discussing marginal utility it is always what the next marginal unit is.

Exactly! It takes a "bigger chunk" to make the individual sufficiently satisfied for the marginal utility to remain the same or increase.

Right on point, but even they get satisfaction from a sufficiently large marginal unit which they can then use to help others.

I think that what many of our friends fail to grasp is the variability of the size of the marginal unit. There are always some marginal units large enough to be satisfying even if attaining that marginal unit pleases us to the point of wanting to give it away to help others. Likewise some marginal units do not satisfy as much thus there is not "increase in marginal utility" and the marginal unit can be of a size by which it is perceived to diminish in marginal utility.

 

Very good post, certainly more detail expressing why marginal utility can diminish. The points you made tell us that perception of desire changes as needs are satisfied and that in some cases that perception can increase, decrease or remain the same. It is all in the perception of the individual who eats the first loaf of bread and the bread truck drops a load at his door stem. Marginal utility that new marginal unit of bread becomes a negative.

I think what distresses people no familiar with the economic meaning of marginal utility comes from thinking of a poor person. Whereas a million dollars may not be enough to increase the marginal utility of a magna rich guy, it is obviously a huge amount for a poor guy. The issue with that kind of thinking is, marginal utility is always what is perceived in the mind of the person receiving the marginal unit.

The whole exercise is used by economists to help them predict consumption or demand equilibrium with existing supply.

 

When I returned to the forum I realized I had not responded to that comment, and it is one of the most important parts of the law of marginal utility as it applies to money. You are so correct in saying that the $100 bill means little to the rich man because his anticipated next marginal unit will likely be so much more of a chunk of money and he would never consider a marginal unit of $100 having sufficient value to concern himself, thus it would be a diminished utility.

 

For me, at least (and I would not presume to speak for others), just "get[ting] by" seems to imply a paycheck-to paycheck existence (or a Social Security check-to-Social Security check existence); and I would certainly agree that this is an unhappy thought.

 

Certainly getting by from check to check is not a pleasant way to life. I went through a period like that and I got by knowing I was better off than a few others I knew

 

Most of us went through our lean days. I was lucky to get my minimum wage job when I started working and couldn't get much more for several years and went back to school. There is nothing like an education to prepare a person for making more money.

Someone posted on one of these threads an article about the difference between educated and non-educated differences in the labor force. It was much like an article I read years ago which prompted me to finally go back to the university. The advice couldn't have been better. I am currently running our company office in The Netherlands and even in a high cost area like Amsterdam I get along very well now.

 

Therein lies the biggest problem with modern economics. On the surface it presents itself as a science by utilizing complex mathematical models (many of which have been borrowed from physics) while the input to those models are obtained through very unscientific means. This is why the predictions of economists are worth less than nothing.

 

I disagree! Economists have been making good predictions for many years. The issue is not the validity of economics, but rather the exploitation by some politicians in the name of economics. Once one recognizes that economics is the science of human behavior applied to economic situation one learns to understand a lot. IOW what gets in the way of economists is politics trying to force the issue with that political skewing.

 

Was invited to join in a new thread which allows virtually anything. http://politicaldiscussion.forumchitchat.com/post/show_single_post?pid=1282583891&postcount=1

 

I don't see the anomaly. As already has been highlighted, a dollar to a poor man is worth more than a dollar to a rich man. The real issue is whether the neoclassical approach is fully understanding behaviour, given it limits the analysis to a simple case of constrained maximisation. For example, we know that comparison across individuals is important. A conspicuous consumption analysis would have to include how money/consumption impacts on feelings of power and self-worth. We're then just highlighting the need for a behavioural economics approach (which will necessarily attack the orthodox, but still can be used to support key conclusions)

 

Please, consider this, do you work now? Would you continue to work in the same job, the same hours?
Be honest, would you continue to work the same job, the same hours, if you had 100 million dollars?

 

I have been retired since 2005.

If 100 million dollars were suddenly to fall into my lap--for good measure, let us make that 100 million dollars after taxes--I would continue to reside in my current dwelling (which is a small condominium; but I really would not care for a mansion); I would continue to pay all my bills promptly (as I currently do); but I might--might--purchase a new vehicle a bit sooner (my current vehicle is a 2004 Chrysler Pacifica SUV--which is not even manufactured anymore--but it still runs great).

Since I would not care to invest so much money in any one financial institution--what if it were to fail?--I would probably just invest most of it in SPIAs (lifetime annuities) and other financial instruments.

 

Unless you have a couple of hundred million now, in which case the marginal utility of another 100 million would be very small, it would affect your life.
I mean at the least, and this is what the winners of lotteries who report the greatest happiness have done, you would share this good fortune with the people you cherish, because reinforcing your connections with the people you care about is the greatest improvement you can make in your life.

 

You'd have to factor in adaptation effects, one potential reason why we don't see a clear link over time between income and happiness

 

I agree it is not an anomaly, but for a different reason. I need, at most, 5 tires for my car. If you give me 105 tires my need is depleted plus I am going to have the zoning people on me to get that big pile of tires, collecting rainwater and breeding mosquitoes out of my yard. Tires have limited shelf lives, so even in the most generous of estimates, there would be zero utility for any tire I had over 9--1 spare and two full sets. Money, however, represents something that I might need in the future. It represents every future need, and given the vast possible needs depending on how uncertainty plays out in reality, makes it hard to know how much is enough, including the uncertainty of the purchasing power of the dollar.

Where one of the arguments is wrong is that some people do become saturated in money and the utility shifts from security on Maslow's hierarchy, to self-actualization/ Bill Gates, Warren Buffet started giving their excess money away, etc because they now feel a present utility in spending the excess on things that give them psychological comfort/pleasure like helping the poor. Put simply, unlike a tire is always going to be a tire, money has a more transient nature, representing different things on any given day to those who possess it.

 

You'd have to show that utility from money is particularly volatile. I don't see that. Indeed, adaptation effects ultimately imply less volatility (as the impact of additional monies tends to zero)

 

The utility of money depends on what you get in exchange for it. If I put $20 up in December, it would have a different utility three weeks ago when gas in my area was 20 cents cheaper a gallon than it does today. If I spend it on dinner tonight it has a different utility than if I purchase a cook book than if I bought 20 cans of tomato soup with it. Money has de minimis utility until it is actually exchanged for something--you can wipe your butt with it or get a few seconds of warmth for your hands if you burn it, but not much more. I do not see how one could argue that money is not the very most volatile thing there is in terms of utility.

 

But the point stands. Once we look into the economics of happiness we do not see the volatility that you refer to. Instead we see paradox effects where extra monies doesn't translate into additional happiness

 

We don't know what it translates to in the future. The money might translate into a whole lot of happiness when it is used to pay for a wedding, or a college education, or an around the world hot air balloon trip that crashes if you are Richard Bransen. Maybe the happiness will be paying to save the life of a friend you presently haven't even met yet. Once person is satisfied that they have more than they need, some might be happy amassing more to leave to their heirs while others might be happy buying themselves the Presidency while others might be happy going to Haiti and throwing a bunch of money on the crowded street to watch kids beat the poo out of each other to get it. Just depends.