Economics Basics: Utility

We have already seen that the focus of economics is to understand the problem of scarcity: the problem of fulfilling the unlimited wants of humankind with limited and/or scarce resources. Because of scarcity, economies need to allocate their resources efficiently. Underlying the laws of demand and supply is the concept of utility, which represents the advantage or fulfillment a person receives from consuming a good or service. Utility, then, explains how individuals and economies aim to gain optimal satisfaction in dealing with scarcity.

Utility is an abstract concept rather than a concrete, observable quantity. The units to which we assign an “amount” of utility, therefore, are arbitrary, representing a relative value. Total utility is the aggregate sum of satisfaction or benefit an individual gains from consuming a given amount of goods or services in an economy. The amount of a person's total utility corresponds to the person's level of consumption, and usually the more the person consumes, the larger his or her total utility will be. Marginal utility is the additional satisfaction, or amount of utility, gained from each extra unit of consumption.

Although total utility usually increases as more of a good is consumed, marginal utility usually decreases with each additional increase in the consumption of a good. This decrease demonstrates the law of diminishing marginal utility. Because there is a certain threshold of satisfaction, the consumer will no longer receive the same pleasure from consumption once that threshold is crossed. In other words, total utility will increase at a slower pace, as an individual increases the quantity consumed.

Take for example a chocolate bar. Let us say that after eating one chocolate bar your sweet tooth has been satisfied. So, your marginal utility (and total utility) after eating one chocolate bar will be quite high. But if you eat more chocolate bars, the pleasure of each additional chocolate bar will be less than the pleasure you received from eating the one before—probably because you are starting to feel full or you have had too many sweets for one day.

This table shows that total utility will increase at a much slower rate as marginal utility diminishes with each additional bar. Notice how the first chocolate bar gives a total utility of 70 but the next three chocolate bars together increase total utility by only 18 additional units.

The law of diminishing marginal utility helps economists understand the law of demand and the negative sloping demand curve. The less of something you have, the more satisfaction you gain from each additional unit you consume; the marginal utility you gain from that product is therefore higher, giving you a higher willingness to pay more for it. This is why prices are lower at a higher quantity demanded: your additional satisfaction diminishes as you demand more.

In order to determine what a consumer's utility and total utility are, economists turn to consumer demand theory, which studies consumer behavior and satisfaction. Economists assume the consumer is rational and will thus maximize his or her total utility by purchasing a combination of different products rather than more of one particular product. Thus, instead of spending all of your money on three chocolate bars, which gives you a total utility of 85, you should rather, purchase the one chocolate bar, which has a utility of 70, and perhaps a glass of milk, which has a utility of 50. The combination would give you a maximized total utility of 120 but would cost the same as the three chocolate bars.