If people make choices on the basis of what’s going to bring them the most happiness, they need a way of comparing how much happiness each option brings.

Utility

Economists suppose that you can compare all possible things that you may experience with a common measure of happiness or satisfaction, which they call utility.

Two important measures are:

Total utility

The overall satisfaction that is derived from the consumption of all units of a good over a given time period.

Marginal utility

The additional utility is derived from the consumption of one more unit of a particular good.

When you look at these numbers, you notice that the extra utility each additional slice brings is decreasing:

First slice:

Total utility increases by 8 utils, from 0 to 8 utils.

Second slice:

The increase is only 6 utils; total utility increases from 8 utils to 14 utils.

Third slice:

Total utility increases only 4 utils, from 14 to 18.

Sixth slice:

Total utility actually goes down, because slice number five can make even the most rabid pizza lover feel a little sick. This decrease in total utility implies that marginal utility must be negative for slice six.

The right column shows the diminishing marginal utility that comes with eating more and more slices of pizza because the marginal utility that comes with each additional slice is always less than that of the previous slice.

Specifically, although marginal utility is 8 utils for the first slice, it falls to 0 utils for slice five and then actually becomes negative for slices six because eating it makes just about anyone ill.




Given that we have limited incomes, we have to make choices. It is not just a question of choosing between two obvious substitutes (like apples and bananas), but about allocating our incomes between all the goods and services we might like to consume. If you have, say, an income of $15 000 per year, what is the optimum ‘bundle’ of goods and services for you to spend it on?

The equi-marginal principle

A consumer is said to be in equilibrium, assuming a given level of income, when it is not possible to switch any expenditure from, say, product A to product B to increase total utility.