Glossary · Economic ideas
Marginal utility
Marginal utility is the extra satisfaction from one more unit of something. It usually shrinks: the first slice of pizza is great, the fifth much less so.
Also called: diminishing marginal utility, law of diminishing marginal utility, utility, diamond–water paradox
In plain words
You are starving and get a slice of pizza: fantastic. The second slice is still very good. By the fourth you are only eating because it is there, and a fifth would make you feel sick. Each extra slice adds less joy than the one before. The extra joy from one more is its marginal utility.
Marginal means “one more”. Economists care less about the total value of things than about the value of the next one, because that is what each choice is about: one more shirt, one more hour of work, one more slice.
That the extra joy usually shrinks is called the law of diminishing marginal utility. It explains why people spread their money over many things instead of buying 30 of the same one.
Example
The diamond–water paradox
Water is essential for life and cheap; diamonds are useless for survival and expensive. Adam Smith found that puzzling. Marginal utility solves it.
- Water is plentiful, so the value of one more glass is tiny: you already have all you need.
- Diamonds are rare, so the value of one more diamond, to someone who wants one, is high.
- Prices follow the value of the next unit, not the total value of all of them.
- Lost in a desert with no water, the order flips: you would trade a diamond for a glass.
Total value and marginal value are different things, and prices follow the marginal one.
One level deeper
The idea was found three times, independently, in the early 1870s by William Stanley Jevons, Carl Menger and Léon Walras: the start of what is called the marginal revolution in economics.
It is one reason demand curves slope down (see supply and demand): people buy more of something only if the price falls to match the lower value of each extra unit. It also underlies the argument that an extra $1,000 means more to a poor family than to a rich one.
It is the classic explanation of why most people dislike risk: if each extra dollar adds less happiness, losing $1,000 hurts more than winning $1,000 helps. Behavioral economists later found that people dislike losses even more than this predicts: see loss aversion.
Why it matters
It explains how people spend: a bit of many things, until the last dollar spent on each brings about the same satisfaction.
It explains prices that seem upside down, like the diamond–water paradox.
It explains why most people dislike risk, and why insurance can be worth paying for.
A common mistake
Myth: Something more useful should always cost more.
In fact: Prices depend on the value of the next unit, which depends on how much there already is. Water is more useful than diamonds, but there is so much of it that one more glass is worth very little.
Questions people ask
What is the law of diminishing marginal utility?
The rule that each extra unit of something adds less satisfaction than the one before: the first glass of water when you are thirsty is wonderful, the tenth is not.
What is an example of marginal utility?
Your first pair of sneakers might change your life; a fifth pair adds much less. All-you-can-eat buffets work because a third plate is worth so little to most people that the restaurant loses little on it.
Can marginal utility be negative?
Yes: one more slice of pizza when you are already full can make you feel worse. That is the point at which to stop.
Read more on BigCapital
About the numbers
- This page explains a term. It is not investment advice.