Marginal Utility

Marginal utility is the relative benefit derived by a consumer from using one more additional unit of a product or service. In this context, utility is the level of contentment provided by a consumer item. Keep in mind a box of your favourite chocolates. Eating a few adds greatly to your enjoyment – eating some more, less so. Then there comes a point when the next one gives you no additional satisfaction. The threshold between the second-last and last chocolates is the margin we’re talking about.

Marginal utility is used widely in marketing and economics to determine how much of an item a consumer will purchase. Market research on the topic has shown that producers sell more product when it is wrapped up in different sizes. Families buy bulkier family packs – couples prefer the standard packs and singletons go for small packs. Hence, more product is sold and more consumers feel satisfied.

Imagine Donald with 2 cans of beans and Hillary with 20 cans of beans. Donald, purchasing the third tin of beans, will get far more utility because of its relative proportion to the total – whereas Hillary will gain far less utility from purchasing the 21st tin of beans. As a consumer buys more, the marginal utility diminishes until it reaches a point where the buyer has no further need for any more beans. At that point, the marginal utility of the next can is zero.

Marginal utility is an important determinant of retail prices. As the utility of a product decreases, consumers are unwilling to pay higher prices. They expect to get it cheaper because it gives them less satisfaction. That’s why product producers love to sell in different sizes. The standard size (1x) at cost (1y) does not appeal to everybody. The family pack (2x) at (1.9y) sells more product; and the smaller pack (0.5x) at (0.75y) produces more marginal income.

In common with most other activities in the modern world, marginal utility has been unwittingly affected by tighter regulations. Security checks at airports insist that liquids should be carried in ever smaller containers. As a consequence, consumers, who would normally not consider such small sizes, perceive enhanced utility and are, therefore, willing to pay more. Manufacturers that sell products outside of regulation size at cheaper prices irrationally lose out.

The financial services’ industry is also subject to marginal utility decisions by consumers – most notably in relation to charges. Basic, standard products that offer no perceived enhanced utility must be given away for free because consumers will not pay for them. Product manufacturers are compelled to provide added features that offer more value for money. Unfortunately, herein, lies a regulatory dilemma. Adding features to financial products tends to make them more difficult for consumers to understand. Marginal utility, therefore, is not as easily identifiable in financial products as it is in other consumer markets.

Warning: MMPI has absolutely no idea how many tins of beans the fictional characters, Donald & Hillary, can conceivably consume!