Utility Theory - Total, Marginal and Average Utility

Summary

In this informative video, EconplusDal explores the concept of utility in economics, focusing on how consumers maximize their utility when making consumption decisions. The video elaborates on the concepts of total, marginal, and average utility using a simple example involving the consumption of Coca-Cola. It explains the law of diminishing marginal utility, which states that as more of a product is consumed, the additional satisfaction from consuming each extra unit decreases. This principle helps determine the point at which total utility is maximized. The video further illustrates how these utility concepts relate to real-world pricing and demand, showcasing that the marginal utility curve is essentially the demand curve.

Highlights

• Understanding utility helps consumers maximize satisfaction.💪
• Marginal utility is the extra satisfaction from consuming one more unit.👍
• The law of diminishing utility explains why additional units are less satisfying.🚶‍♂️
• Total utility peaks when marginal utility equals zero.📈
• Relating utility to price helps in rational consumer decision-making.🛍️

Key Takeaways

• Consumers aim to maximize utility when making consumption decisions.💡
• Marginal utility decreases with additional consumption, known as the law of diminishing utility.📉
• Total utility is maximized when marginal utility is zero.🔝
• Price plays a crucial role in determining the quantity consumed based on utility.💰
• The marginal utility curve represents the demand curve.📊

Overview

In this engaging video by EconplusDal, we dive into the world of utility theory in economics. The main focus is on how consumers make consumption decisions to maximize their utility, or satisfaction. Through a relatable example involving cups of Coca-Cola, the video explains total, marginal, and average utility. We discover that the satisfaction, known as utility, decreases with each additional cup consumed, illustrating the law of diminishing marginal utility.

EconplusDal expertly guides us through the mechanics of utility curves, where marginal and average utility curves slope downward due to diminishing marginal returns. The video depicts how total utility peaks and then falls as more units are consumed, ensuring we grasp the critical point where satisfaction is maximized, and marginal utility hits zero. It's a compelling illustration of consuming wisely!

Finally, the video makes a crucial connection between utility and real-world economic behavior. By equating price to utility, it shows how consumers decide on the number of units to buy to maximize utility. This relationship helps us understand that marginal utility not only reflects personal benefit but aligns with the demand curve in economics, painting a richer picture of consumer decision-making in the marketplace.

Chapters

• 00:00 - 00:30: Introduction to Utility Theory The chapter titled 'Introduction to Utility Theory' discusses the fundamental concept in neoclassical economics where different agents such as firms, governments, workers, and consumers aim to maximize their respective utilities, profits, and welfare. It specifically focuses on consumer behavior, explaining the rationale behind why consumers make specific consumption decisions to maximize their utility.
• 00:30 - 01:00: Example of a Consumer Maximizing Utility This chapter provides an analysis of consumer behavior, specifically focusing on an individual's strategy to maximize utility when consuming Coca-Cola. The scenario involves a person who is extremely thirsty. A table illustrates the total utility gained from consuming additional cups of Coca-Cola, with an emphasis on understanding the concept of marginal utility—the additional satisfaction obtained from consuming one more unit of a good.
• 01:00 - 02:00: Calculating Marginal and Average Utility The chapter titled 'Calculating Marginal and Average Utility' focuses on the concept of marginal utility, which is the additional satisfaction or utility gained from consuming one more unit of a good, in this case, Coca-Cola. The transcript explains that utility simply refers to satisfaction and provides an example sequence illustrating the diminishing marginal utility with each additional cup consumed, starting with utility values of 8, 6, 4, 2, 0, and eventually -2 as more are consumed.
• 02:00 - 03:00: Plotting Utility Curves The chapter titled 'Plotting Utility Curves' discusses the concept of average utility, calculated as total utility divided by quantity, resulting in values like 8, 7, 6, 5, 4, and 3. It also explains marginal utility as equivalent to marginal private benefit when a unit is consumed, highlighting that utility is essentially satisfaction. The chapter ends with an invitation to plot utility curves based on the discussed data.
• 03:00 - 04:30: Law of Diminishing Utility Explained The chapter titled 'Law of Diminishing Utility Explained' discusses utility curves, focusing on the marginal utility curve and the average utility curve. The axis labeling on these graphs is important: the y-axis is marked in 'utils,' representing units of satisfaction, while the x-axis shows quantity, exemplified by cups of Coca-Cola. Both the marginal and average utility curves are downward sloping, illustrating the principle known as the law of diminishing utility. This concept explains that as more of a product is consumed, the additional satisfaction gained from consuming each additional unit decreases. The chapter also refers to a table where this downward slope is clearly depicted.
• 04:30 - 05:30: Maximizing Total Utility In this chapter titled 'Maximizing Total Utility,' the concept of the law of diminishing utility is explained. This law states that as the quantity of a good consumed increases, the additional satisfaction or marginal utility derived from each additional unit decreases. This is because the initial units of consumption provide the most significant level of satisfaction, as illustrated with the example of a thirsty person drinking their first cup of coke.
• 05:30 - 07:30: Price and Utility in the Real World In this chapter titled 'Price and Utility in the Real World,' the concept of diminishing utility is explored using the example of consuming cups of coffee. Initially, a high level of utility or satisfaction is gained from the first cup, with subsequent cups still providing utility but at a decreasing rate. By the fifth cup, no additional utility is achieved. Drinking a sixth cup begins to have a negative effect, highlighting the diminishing utility
• 07:30 - 10:00: Marginal Utility as Demand Curve In this chapter, the concept of marginal utility is discussed, specifically in the context of it serving as a demand curve. It explores the law of diminishing utility, which suggests that as more of a good is consumed, the additional benefit derived from each extra unit decreases. This principle is exemplified by the development of negative marginal utility, where a consumer might start to feel discomfort or sickness from overconsumption. The chapter explains how this concept helps determine where a consumer seeks to maximize their total utility.

Utility Theory - Total, Marginal and Average Utility Transcription

• 00:00 - 00:30 hi everybody according to traditional neoclassical thought economic agents will always look to maximize their benefit that is firms maximizing profits governments maximizing the social welfare of their citizens uh workers maximizing the welfare they derive at work and consumers maximizing their utility when they make consumption decisions in this video we're going to isolate utility Theory and understanding more detail why consumer should consume in order to maximize their utility when they make consumption decisions
• 00:30 - 01:00 let's go straight to this table and assume there is an individual who is dead thirsty really parched and is looking to maximize the utility when it comes to drinking cups of Coca-Cola so I've drawn a table here and you got cups of Coca-Cola on the left hand side I've also put in numbers for total utility derived when more cups of Coke are drunk we want to work out the marginal utility remember the marginal concept the marginal is always the extra derived when one more is consumed or one more is produced right so in this case what is
• 01:00 - 01:30 the marginal utility the marginal utility is the extra utility gained when one more cup of Coca-Cola is drunk okay so the extra utility generated when an extra unit has been consumed utility guys just means satisfaction so keep it simple like that so what is the marginal utility well when the first cup is drunk it's eight then it's uh six then it's four then it's two 0 and minus 2 okay so the extra utility generated when one
• 01:30 - 02:00 more cup of Coca-Cola has been drunk what about average utility well the average utility is just the total utility divided by the quantity and that gives us 8 7 6 5 4 and three very simple another way of looking a marginal utility is by saying the marginal utility is equal to the marginal private benefit when a unit is consumed and if you think about it if utility is satisfaction they both mean exactly the same thing so bear that in mind as we go through the video as well so let's take this data and plot some curves the
• 02:00 - 02:30 margin utility curve and the average utility curve first thing to say is how we label the axis the y- axis if we're drawing utility curves must be labeled utils where utils is just units of satisfaction and on the x-axis we have quantity in terms of cups of Coca-Cola so if I plot my marginal utility and average utility curves I get something that looks like that and you can see that both are downward sloping and they are downward sloping because of the law of diminishing utility the downward slope can be clearly seen in the table
• 02:30 - 03:00 here and the reason is due to the law of diminishing utility which states that as more quantities consumed so as quantity consumed increases the marginal utility derived from each extra unit decreases so as quantity consumed increases the marginal utility derived from each unit actually decreases that is the law of diminishing utility it makes sense doesn't it the idea is very simple when that person drinks the first cup of coke they are So Thirsty they are so parched
• 03:00 - 03:30 it generates huge utility eight units of utility for that one for that first cup of Co but then the next one still generates more utility but not as much as the first the one after that again generates more utility for utils in this case but not as much as the second and that happens until we get to the fifth unit when the fifth unit is drunk right there is no more utility to be gained compared to the fourth one yeah and then if that consumer drinks the sixth unit what happens starts to feel worse right
• 03:30 - 04:00 maybe feels a bit bloated feels a bit gassy feels a little bit sickly right and that's what we mean when we have negative marginal utility that consumer starts to feel worse so the law of diminishing utility is very clear in this case the more that is consumed the less benefit we derive from each unit that we are consuming very simple concept here so can we apply that concept the low diminishing utility to then explain where a consumer will look to maximize their total utility well absolutely um from the table and also
• 04:00 - 04:30 from the diagram on the right hand side we can clearly see that total utility is maximized when this consumer stops at the fifth cup of coke at the fifth cup of coke total utility has been maximized if this consumer goes one more total utility starts to decrease so what we can say more clearly is that total utility is maximized where marginal utility is equal to zero so where marginal utility is equal to zero that is where total utility is maximized
• 04:30 - 05:00 it doesn't make sense stopping at a quantity below five in this case because more utility could be generated if more units of or more cups of cola are drunk and it doesn't make sense to consume Beyond five because then marginal utility goes negative bringing down total utility if I draw the total utility curve this is not exactly plotted but roughly plotted we can see that it looks like this and the peak of the total utility is hit at the quantity of five again the shape of total utility
• 05:00 - 05:30 is derived due to the law of diminishing utility total utility increases but at a slower rate as more quantity is consumed because marginal utility is decreasing up until we hit the peak where marginal utility is zero total utility is maximized and then if we consume more cups of Coca-Cola after 5 units total utility comes down because marginal utility goes negative at that quantity level okay so that makes it very clear
• 05:30 - 06:00 that a rational consumer looking to maximize their utility will consume units up until where marginal utility is zero let's Now understand if we can apply this idea more realistically to the real world in the real world Economist simplify things and say that price is equal to utility so therefore we can amend our y- AIS given that assumption that economists have and say that we can have price on the y- AIS as well as utils so if price is equal to
• 06:00 - 06:30 utility where will a rational consumer look to maximize their utility well it makes sense to consider this because in the real world there are prices for goods and services right so let's take an example here and let's say that a price the price of a cup of Coca-Cola is equal to4 where will a rational consumer consume to maximize the utility when they drink cups of Coca-Cola well they'll keep consuming units as long as what they are getting is more than what they are paying I.E they're paying £4 in
• 06:30 - 07:00 each case if the utility they're getting is more than £4 then it's worth consuming that unit so is it worth consuming the first unit yes because the first unit generates 8 pound worth of utility they're only paying 44 the second unit generates six pound worth of utility they're only paying 44 so buy that one the third unit generates 44 worth of utility and they're paying £4 so it makes sense to consume that one as well does it make sense to consume the fourth unit the fourth unit generates two pound worth of utility but the
• 07:00 - 07:30 consumer is paying £4 so it doesn't make sense to consume that unit at all so it makes sense to keep consuming units as long as the utility being derived is more than what is being paid for I.E a rational consumer when there is a price involved will maximize the utility by consuming up until marginal utility is equal to the price okay we've made it very clear there but we can actually make a conclusion that is a bit deeper than that as well we said that the marginal utility is equal to the
• 07:30 - 08:00 marginal private benefit what we're going to prove now is that the marginal utility curve is also the demand curve let's go back to four okay so the price of a cup of Coca-Cola is £4 and we said that a rational consumer will maximize their utility by buying uh three cups of Coca-Cola at that price let's now say that the price goes up to6 if the price goes up to6 how many how many cups of Coca-Cola
• 08:00 - 08:30 should a rational consumer looking to maximize their utility buy well they should buy the first one because that generates 8 pound of utility and they're only paying for six they should buy the second one because that generates six6 worth of utility and they are paying for six they are paying six so it makes sense for that consumer to purchase two cups of Coke so when the price has gone up from £4 to6 the quantity demanded has fallen hasn't there less cups of Coca-Cola are being drunk now three when it was £4 and now only two when the
• 08:30 - 09:00 price has gone up to6 what if the price Falls to2 what if the price Falls to 22 does it make sense drinking the first cup of Coca-Cola yes if that generates 8 of utility the consumer is only paying for two the second generates six only paying two the third generates four only paying two the fourth generates two pounds worth of utility and that's what the consumer is paying so it makes sense for a rational consumer to buy four cups of caol to maximize their utility and we
• 09:00 - 09:30 can see compared to a price of4 that is an increase in quantity demanded so we can see that when the price goes up there is less quantity demanded when the price goes down there is more quantity demanded and that is because when the price goes up less units will satisfy this condition of maximizing utility where mu equals P whereas when the price goes down more units can be consumed to maximize utility given the condition of marginal utility equals price being the maximization point when a price is
• 09:30 - 10:00 involved so therefore we can say that the marginal utility is the demand curve so marginal utility yes is the marginal private benefit which is why we draw downward sloping with market failure diagrams but it's also equal to demand I.E it's also the demand curve so now you know in more detail why the demand curve is down sloping where does it come from it comes from the law of diminishing marginal utility that is the deeper idea behind it and that is
• 10:00 - 10:30 underpinning of really what economics is all about so bear this all in mind very important stuff thank you so much for watching guys hope that all made sense I'll see you all in the next video