Marginal Utility

Marginal utility and marginal benefit. How you would spend $5 on chocolate and fruit

What I wanna do in this video is think about a concept

that we've already thought about multiple times

in the context of many many videos

and this is the idea of utility

which is really just a way of saying

how much benefit, or satisfaction, or value

do you get out getting a good or service

but the angle that we're gonna take in this video

is gonna be slightly different

in the past when we were measuring benefit or value

we either measured in term of dollars

or we said hey

the benefit of getting an incremental Honda Civic

was 5,000 dollars

and when we're talking about incremental

we're talking about the marginal benefit

or early on, when we talked about

the production possibilities frontier

and when we talked about the marginal benefit

of getting another squirel

we were talking about it in terms of berries

we were talking in terms of another good or service

but what we're gonna do in this video

is just think about it in absolute terms

we're just gonna think of some arbitrary way

of measuring utility

and then just assign values to

what's the value of getting one chocolate bar

and then what's the value that we give

to the next chocolate bar and chocolate bar after that

we're gonna do the same things about fruit

and from that we're gonna see

if we can kind of built up some the things

that we already know about demand curves

and how things relate to price

and the price of other goods and things like that

and in particular we're gonna focus on marginal utility

so obviously you could have total utility

if I have four chocolate bars you could say that

the total utility I am getting from all four of them

or you can think of the marginal utility

the utility I am getting

from the next incremental chocolate bar

or the next incremental pound of food

and before I move on there's one thing

this was a point of confusion for me

when I first learned this

ok I am using the word marginal utility now

-in the past I've used the word marginal benefit-

they sound very similar

in fact I even used the word benefit

when I defined marginal utility

How are these things different?

And the simple answer is

conceptually they aren't

conceptually they are the exact same thing

though the difference is

how the words tend to be used

in the context of traditional microeconomics class

so when people talk about utility

they tend to measure

in terms of some type of absolute measure

that they just came up with

some type of you could view it as utility units

some type of satisfaction units

while when they talk about marginal benefit

they tend to measure it

either in dollars or in terms of some other goods

but I've seen either term used either way

so they really do mean the exact same thing

but in this video we're gonna use the term utility

and we're gonna come up with measuring scale

and it's somewhat arbitrary one

and we're gonna use that

to come up with some conclusions

about the basket of goods someone might purchase

depending on different prices

so as you can imagine, I prewrote these two things

we're gonna talk about chocolate bars

and we're gonna talk about fruit

so right here in these little tables here

I've shown the marginal utility of each incremental bar

and in case of fruit of each incremental pound of fruit

so this is saying that first chocolate bar

obviously if I have no chocolate bars

I am getting no utility from chocolate bars

and this is saying that the first chocolate bar

has a marginal utility

so the utility of that next icnremental one is a hundred

I'm not saying a hundred dollars

I'm not saying

it's equivalent to a hundred pounds of fruit

I'm not saying it's equivalent to a hundred berries

I'm just saying arbitrarily saying it is a hundred

and what matters is not that

this is a hundred or thousand or million

what matters is how this compares to others things

so for example

if I would say that this is a hundred

and if I know that I like fruit

a pound of fruit 20 percent more than that first

or if I like an incremental

-my first pound of fruit-

20 percent more

then I would have to say that the marginal utility

of my first pound of fruit is 120

and this is what we said right over here

and if another way to think about it is

if the marginal utility of the second chocolate bar I get

because I've already enjoyed a little bit of chocolate bar

and I am a little "chocolated" out

is 20 percent less than that

then if this is a hundred that this would have to be 80

I could have said this to be 1000

and this to be 800

and this to be 1200

I could have said this to be 10

and this to be 8

and this to be 12

what matters is that

they really just have the same ratios between them

that really do reflect much actual preferences

so let's just think about this a little bit

my first chocolate bar I am pretty excited

I just call it a hundred

the next chocolate bar

I am a little bit less excited about it

I've already had some chocolate

my craving has been satiated to some degree

but I still like chocolate so I'll call that an 80

we can call it 80 satisfaction units

whatever you wanna call it

then the next chocolate bar after this

now I am starting to get pretty stuffed

and I am really "chocolated" out

and so I am not getting as much benefit from it

and then finally if you give me another chocolate bar

it's even less

and if we were to list fifth chocolate bar

I might not want it at all

my marginal utility might go to zero

for that fifth chocolate bar

maybe for that sixth chocolate bar

I have to somehow get rid of it

I am so tired of chocolate bars

maybe I have a negative marginal utility

and we can think about the same thing with fruit

the first pound of fruit

I am pretty excited about fruit

I have a fruit craving

I like that first pound of fruit

even more than that first chocolate bar

I like it 20 percent more

so I get 120, you could call it utility points

or whatever arbitrary you want to call it

then my next pound of fruit

once again, I am having diminishing utility

diminishing benefit

as I get more and more incremental pound of fruit

now, it's very important to realize

this is marginal utility

not total utility

this is the utility I am getting from each incremental pound

it's positive

so I am still enjoying that next incremental pound

I am just enjoying it little bit less than the pound before

and to realize what total utility is

if I were to have to pounds of fruit

I would get 120 of utility from that first pound

and I would get a 100 from that second pound

and so you would say I had a total utility of 220 utility units

from both pounds

now with just the information that I've given here

there are few things you could say

you could say well look

my first pound of fruit I enjoy more

20 percent more

than my first chocolate bar

you could also say my second pound of fruit

I derive about the same amount of value

as my first chocolate bar

you could say that my second chocolate bar

I enjoy less than my first chocolate bar

you could even say 20 percent less

if these numbers are good

but it still doesn't give you a lot of information

about how you would actually spend your money

you might say

obviously wouldn't you just want to buy fruit

over chocolate bars

or at least that first pound of fruit

over that first chocolate bar?

well you might

but it depends on how much fruit actually cost

just looking at this alone

we can just make relative judgements

about how much we prefer each incremental bar

or each incremental pound

or them relative to each other

but it really doesn't tell us

how we would spend our actual money

so let's think about things

let's put some prices on some of these goods

and think about we would actually allocate our dollars

given these marginal utility numbers right over here

so let's say that the chocolate bars are 1 dollar per bar

and let's say that the fruit is 2 dollars per pound

2 dollars per pound

so this is going to be per pound

and this is going to be per bar

and what we're gonna think about is

we're gonna think about marginal utility

for that incremental chocolate bar per price

of that incremental chocolate bar

here the price is gonna be at a dollar per pound

so here for that first bar

I am going to be spending a dollar

and I am getting a hundred marginal utility points

whatever you want to call it

so I am getting a 100 marginal utility points

for that dollar

so I'm getting a hundred

a hundred marginal utility points per dollar

Here, same logic

I am getting 80 marginal utility points per dollar

this is pretty simple math

here I am getting 60 marginal utility points for the dollar

her I am getting 40

so that doesn't seem too interesting

it might be a little bit more interesting here

what is the marginal utility per incremental fruit

that I am getting per dollar

per price

or I should say per price of the incremental fruit here

well here, the first pound of fruit

I am getting 120 marginal utility points

but I paid 2 dollars for it

so 120, let me write it over here

so for that first incremental fruit

the marginal utility for that first fruit is 120

and the price for that first pound of fruit is equal to 2

so I am getting 60 marginal utility points per dollar

I'm getting 60

here 100 marginal utility points

but I am spending 2 dollars

so it's 50 points per dollar

this is 25 points per dollar

this is 10 points per dollar

now this makes things a little bit more interesting

if I had 5 dollars to spend

how would I want to spend my 5 dollars

well where am I getting the most

you really want to just think about

where you're getting the most satisfaction for each dollar

where you're getting the most bang for your buck

so where am I going to spend my first dollar

so dollar one:

let's think about it a little bit

my first dollar

so dollar one:

my first dollar

where am I going to get the most satisfaction per dollar

well I get the most satisfaction per dollar right over here

I get a 100 satisfaction units per dollar

even though I like a pound of fruit more

I am getting less satisfaction per dollar

so I am getting less bang for my buck

so my first dollar is going to go right over there

I am going to buy one candy bar

then where am I going to spend my second dollar

dollar two:

so once again, I just wan to look at all my options

and we're gonna assume that

I am going to spend my dollar on either of these two

just to limit our universe

once again I am gonna maximize my bang for buck

I get 80 satisfaction points

or marginal utility points over here per dollar

and I only get 60 over here

so I am gonna buy a second chocolate bar

let's keep going

where am I gonna spend my third dollar

now it gets a little bit interesting

I could spend my third dollar right over here

and get 60 points per dollar

or I could spend it over here

and get 60 points per dollar

I would actually get the same amount

these are both 60 points per dollar

so I am kind of neutral

I am getting the same bang for my buck

whether I get another chocolate bar

or whether I get another fruit

so just for simplicity

let's say I get another chocolate bar

I could have got the fruit too

so it's really a toss-up

I could flip a coin

and I choose to get another chocolate bar

so I spent my first three dollar on three chocolate bars

now, where am I going to spend my fourth dollar

well my fourth dollar

now my best bang for my buck

isn't to get another chocolate bar

I am only going to get 40 points per buck there

now it is to spend it on fruit

so now the next dollar I could spend on half a pound of fruit

and I would get this

so my fourth dollar, I could spend on this

for half a pound of fruit

because it's two dollars per pound

and then I could spend my fifth dollar there too

so this is my fourth and my fifth dollar

because it's two dollars

you could think of it we're spending

2 dollars for one pound of fruit

and we're getting 60 utility points per dollar

so we're getting the best bang for our buck right over there

but what was useful about this is that it allowed us

without thinking money

just say how much do we like these things

irrespective of their actual price

and then given a certain price

it allowed us to think rationally

about how would we actually spend our money

in this case when chocolate bars are a dollar

and fruit is two dollars per pound

we decided to buy three chocolate bars

and only one pound of fruit