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Marginal Utility Theory

By lethora Nov 27, 2013 1034 Words
Discuss whether marginal utility theory is a realistic piece of economic analysis in explaining consumer demand. [13marks]

Marginal utility is the extra satisfaction gained from the consumption of an additional unit of a good or service. It can be specified as the change in total utility divided by the change in quantity. The concepts of market demand and law of demand often utilized marginal utility as the backbone, the theoretical basis. An example would be the demand curve, which is usually download sloping due to the law of diminishing marginal that states that successive units of consumption will eventually result a reduction in marginal utility.

One of the main assumptions of marginal utility theory is the dogma that consumers are capable of rational decision-making and to maximize their utility under the conditions of limited income, given set of prices and constant tastes. The inconsistencies, irrationalities or any peculiar forms of consumers’ behaviors can be disregarded on the basis of law of large numbers. Law of large numbers affirms that by taking an increasingly larger quantity of samples, a closer true average of the sample population can be achieved. This law avails to minimize prediction error and refine the flaws of marginal utility theory as economic model. However, it is still fatuous to generalize that consumers are consistently rational, even after omitting the anomalies, as the power of effective advertising and increasing choices can largely affect consumer’s behavior. In the 21st century, cogent and persuasive advertising possess the ability to develop brand loyalty in consumers and even leading monomania in some. A good example of this phenomenon would be the swift rise in popularity of Apple’s IPhone and other products. Endless research, testing and articles have insinuated that there are many smartphones in the market, which are more affordable and better than IPhones in terms of internal compartments, processor and usability; yet, many consumers are so attached to the reputation, trend and popularity of IPhones that they often ignore the more ideal, rational choice. The loyalty to Apple by the users is so deeply engrained that it has enabled Apple to overtake Microsoft as the biggest technology company and higher market share than Google.

The notion that consumers are able to maximize their utility by being rational with decisions, to a certain extent, is also a fallacy. The huge variety of choices available in today’s society has undermined the idea of utility and the freedom of consumer demand. Choosing the right decision to gain maximum satisfaction is difficult as when more choices are present, it is in individuals’ innate nature to imagine the other benefits they could have other than the choice they finalized on. Thus, individuals have the tendency to regret even if the choice they have decided is the best one. Besides that, high expectations often are resulted from vast choices. Therefore more choices will be reflected upon consumers as opportunity costs and those opportunity costs could subtract the satisfaction from their choices due to regret and disappointment from high expectations. One can conclude from this point that an accurate measurement of utility derived from demand of a consumer is an arduous journey.

Another assumption on marginal utility theory is that utility can be measured. Cardinal utility presumes that satisfaction is a quantifiable characteristic of human activity therefore can be measured with numerical values based on a benchmark scale in the unit of utiles. The argument against cardinal utility is ordinal utility, which proposes that utility is subjective thus should be ranked in order of preference by comparing on a relative basis. In this case, consumers are only required to state whether one good is more or less preferred than another instead of comparing on value of two goods. This rationale is more realistic as it provides a more solid theoretical basis for the analysis of consumer demand. Nevertheless, cardinal utility is hypothetical in the realm of economic analysis as it does provide insight into consumer behavior and demand.

In the economic analysis of marginal utility theory, the demand curve is identical to the marginal value curve, which are both downward sloping, as at any price, a quantity for which marginal value equals the price is bought. However, there are few exceptions. Giffen good is an example that violates the law of demand. Its demand rises when price increases and demand falls when the price decreases. Giffen goods lack substitutes and it must be an inferior good, but most inferior goods are not Giffen goods. Inferior good is a good with demand that declines as the level of income increases. Another exception is high-status goods such as perfumes and designer branded bags, which are often known as Veblen good. Demand and marginal utility for Veblen goods increase as their prices increase because people perceive them to be exclusive and with conspicuous and ostentatious motive. These two goods have a demand curve, which is upward sloping. In the case of Giffen good, a good example would be bread in the 19th century as a rise in the price of such essential good takes a incredibly large proportion on the income of poor labouring families that it has the effect to raise marginal utility of money to them and curtail their consumption of more expensive food.

The assumptions of marginal utility theory may be too superficial and not realistic enough for the modern society; however, an economic model as such is deliberately designed to simplify reality by providing a basic framework for analyzing, organizing ideas on economic theories and understanding economic decisions. In some aspects, marginal utility theory is monistic as it presumes that the price formation consists of only consumption, which utility is derived, and the forces influencing price formation are from the perspective of consumers. It hugely differs to another classical political economy theory that considers the basis of prices to be value, which is associated with production processes. Despite the fact that there are many loopholes in the theory, exceptions and few contradictions to the laws of formal logic, it is nevertheless effective in aiding economic analysis in explaining consumer demand. The limited set of postulates is able to lead to reliable and consistent conclusion from using the model.

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