Term
Category
Characteristics
Utility is an
economic concept that
Represents the amount
of benefit or satisfaction
received from the
consumption of a good
or a service.
Marginal utility is an
economic concept that
Refers to the amount of
benefit received from
each additional
increment of
consumption of a good
or a service
Diminishing marginal
utility is an
economic concept that
Suggests that each
additional increment of
consumption of a good
or service begins to
bring about less
marginal utility.
AOF
Business Economics
Unit 2, Lesson 4
Utility and Diminishing Returns
Copyright © 2008–2012 National Academy Foundation. All rights reserved.
“Too much of a good thing” is an economic concept
Economists are interested in the
utility (value) that we attribute to
things that we consume.
• Why does a cold drink taste so
good after playing sports?
• Why doesn’t the second drink
taste quite as good as the
first?
• And the third even less
appealing?
• And the fourth? Not unless you
want to get sick.
Utility is a useful concept because
it offers some indication of how
much a person might want
something, or for that matter be
willing to pay for it.
Picture of Sweaty Basketball
player drinking
The answers are utility,
marginal utility, and
diminishing marginal utility.
Economics measures the value a good provides
• Marginal Utility:
The benefit that one more
instance of an item will give us
(when consumed in a certain time
period, e.g., a day), and therefore
what we’re willing to pay for it
• Diminishing Marginal Utility:
The decline in the benefit that
each additional instance of an
item brings when consumed
• Total Utility:
The sum of all the benefit gained
from the consumption of all the
instances of an item, in the same
time period (as indicated by what
we’re willing to pay for them)
Gatorades
Consumed
Marginal Utility
of Each
Gatorade
Total Utility of the
Gatorades
Consumed
0
$0
$0
1
$ 1.59
$ 1.59
2
$ 0.99
$ 2.58
3
$ 0.10
$ 2.68
4
$ 0.02
$ 2.70
5
$0
$ 2.70
At a certain point, consuming more of something
provides no extra benefit
Sports Drink Diminishing M arginal Utility
V alue o f N ext D r ink
$3.00
$2.70
$2.58
$2.50
$2.68
$2.70
$2.00
$ 1. 5 0
$ 1. 5 9
$ 1. 5 9
$ 1. 0 0
$0.99
$0.50
$1
$ 0 . 10
2
$0.02
3
$-
4
Marginal Gatorade
Utility
5
N umb er o f D r inks
C o nsumed
Purple – Marginal Utility (the value each additional Gatorade brings to you or
the amount you would pay for each additional one).
Tan – Total Utility. It doesn’t drop to zero, it climbs up and stays there. (It is
the sum of all value gained from consuming a good)
Utility can help businesses make
decisions
• Gatorade factory tries to
produce the right amount
of Gatorade to satisfy the
thirsty kids’ wants.
• It wants to do this while
earning as much profit as
possible.
• So how many workers
should the factory hire?
• If you hire too many and
produce too much, the
price could
!
Diminishing marginal returns – applies to
producers (businesses). Has to do with how
many workers a business employs in order to
operate efficiently
Term
Definition
allocative
efficiency
The provision of the right amount of goods and services,
taking into account consumers’ preferences, the
production possibilities provided by technology, and the
scarcity (and hence price) of each of the production
inputs used.
comparative
advantage
An economic principle, used most in the theory of
international trade, which states that a country should
specialize in producing those goods where its advantage
in productivity and costs, relative to its own productivity
and costs in producing other goods, is greatest.
diminishing
marginal utility
The tendency for the marginal utility associated with
each additional increment of the consumption of a good
or service to diminish, as the consumer consumes a
larger amount of the good or service.
diminishing
returns
An economic concept stating that using increasing
amounts of a particular input (e.g., labor hours) in
production, beyond a certain level, increases output less
and less.
marginal
physical product
(MPP)
The MPP is the amount of additional production of a
good (or service) that results from using one more unit
of an input (e.g., hours of labor).
marginal utility
The amount of benefit or satisfaction received from each
additional instance of consumption of a good or a
service.
production
efficiency
The manufacture of the desired output with the
minimum amount of effort, expense, or waste while
taking account of the costs and benefits associated with
a particular choice of what outputs to produce, and what
inputs to use in producing them.
specialization
Concentration of economic activity on the production of
a few particular goods or services.
utility
The benefit or satisfaction gained from the use of a good
or a service.