Marginal Utility

In economics, marginal utility refers to the additional utility derived by a consumer from the purchase of one more unit of a good. More formally, it is the rate of change of utility with respect to changes in the quantity of goods purchased (the first derivative). The concept is crucial in economic theory because decisions about how much of a given good to purchase are thought to be made on the margin; that is, the agent asks himself or herself, with respect to each additional unit of any good (whether oranges in the grocery bag or dollars of life-insurance coverage), whether his or her expected utility from purchasing it is sufficient to justify its cost. He or she may also consider whether a substitute expenditure elsewhere, on a different good, would produce superior benefits in terms of utility.

Over a wide range of goods, marginal utility is diminishing. That is, the utility gained from each additional unit is less than that gained from the previous unit. Mary, for example, may get considerable utility from owning one bicycle. She is apt to get some, but less, utility out of purchasing a second. It is not as vital to her transportation or recreational needs as the first, but could add convenience because, for example, it could be used as a backup when the first bicycle breaks down or could be lent to visiting friends. But the marginal utility of Mary's acquiring a third bicycle is apt to be rather small. When the cost to Mary of buying another bicycle exceeds her expected utility from it, she will stop buying bicycles. (Up until that point, Mary has actually gained something from each transaction, since her marginal utility in each case has exceeded the price she's had to pay. The amount by which a consumer's marginal utility exceeds the price is known as consumer surplus.)

Money, too, has diminishing marginal utility. The move from being penniless to having 10 dollars entails a much more significant increase in utility than the move from having a million dollars to having a million and 10 dollars, even though 10 dollars are added in each case.

Diminishing marginal utility is used by some ethicists to justify wealth redistribution, especially via progressive income taxation. The argument is that any transfer of X dollars from a rich person to a poor person will increase overall social welfare. This is because the diminishing marginal utility of money guarantees that the decrease in welfare experienced by a wealthy person losing X is smaller than the increase in welfare experienced by a poor one gaining X. This argument is not fully persuasive, however, since the pricedistortion brought about by taxation may result in deadweight loss—loss of social productivity—that offsets the welfare gain from the transfer.