Choices Are Made at the Margin

Economists argue that most choices are made “at the margin.” The margin is the current level of an activity. Think of it as the edge from which a choice is to be made. A choice at the margin is a decision to do a little more or a little less of something.

Assessing choices at the margin can lead to extremely useful insights. Consider, for example, the problem of curtailing water consumption when the amount of water available falls short of the amount people now use. If you live east of the Mississippi River in the U.S., this is not likely to be a problem for you, but it’s very common in the West. (For a historical example, check out the movie Chinatown.)  Economists argue that one way to induce people to conserve water is to raise its price. A common response to this recommendation is that a higher price would have no effect on water consumption, because water is a necessity. Many people claim that prices do not affect water consumption because people “need” water.

But choices in water consumption, like virtually all choices, are made at the margin. Individuals do not make choices about whether they should or should not consume water. Rather, they decide whether to consume a little more or a little less water. Household water consumption in the United States totals about 105 gallons per person per day. Think of that starting point as the edge from which a choice at the margin in water consumption is made. Could a higher price cause you to use less water brushing your teeth, take shorter showers, or water your lawn less? Could a higher price cause people to reduce their use, say, to 104 gallons per person per day? To 103? When we examine the choice to consume water at the margin, the notion that a higher price would reduce consumption seems much more plausible. Prices affect our consumption of water because choices in water consumption, like other choices, are made at the margin.

In exploring consumer choices, it’s important to differentiate between total utility and marginal utility. Marginal utility is based on the notion that individuals rarely face all-or-nothing decisions, that most of the time they are considering a little more or a little less of something when allocating their budget, time or other scarce resources. So a student might ask, “how much better will I do on an exam if I study for one more hour?” The answer could be called the marginal grade improvement. Marginal utility, then, is the change in total utility from consuming one more or one less of an item. For example, the marginal utility of a third slice of pizza is the change in satisfaction one gets when eating the third slice instead of stopping with two.

As we continue to study microeconomics, we will see a number of additional marginal concepts. The general formula for computing a marginal outcome is the change in the outcome divided by the change in the number of inputs used to produce that outcome. For example, if two more hours of work yields an additional $20 in wages, the marginal wage earned is $20/2 hours = $10 per hour. The marginal cost of one more unit of output a firm produces is the amount that total cost increases when the firm produces one more unit of output.

Marginal Utility and Total Utility

In Table 1 below, we repeat the information on total utility shown in Table 2 on the previous page, but we also include marginal utility.

The third column of Table 1 shows marginal utility, which is the additional utility provided by one additional unit of consumption. This equation for marginal utility is:

Figure 1. Marginal Utility Curve. Marginal utility decreases as consumption of a good increases. This illustrates the Law of Diminishing Marginal Utility.

Figure 1 shows the graph of marginal utility. Notice that marginal utility diminishes as additional units are consumed, which means that each subsequent unit of a good consumed provides less additional utility. For example, the first T-shirt José picks is his favorite and it gives him an addition of 22 utils. The fourth T-shirt is just something to wear when all his other clothes are in the wash and yields only 18 additional utils. This is an example of the law of diminishing marginal utility, which holds that the additional utility decreases with each unit added. Marginal utility is always maximized with the first unit of something consumed, and then gradually declines, even while total utility is increasing. Diminishing marginal utility is another example of the more general law of diminishing returns we learned about earlier in the module on choices and budget constraints.

Marginal utility for movies (column 6) also follows the expected pattern: each additional movie brings a smaller gain in utility than the previous one. The first movie José attends is the one he wanted to see the most, and thus provides him with the highest level of utility or satisfaction. The fifth movie he attends is just to kill time. Notice that total utility is also the sum of the marginal utilities.