What is Marginal Utility?

The concept of marginal utility is key to understanding consumer behaviour. Marginal utility generally declines with higher consumption. Savings play an important role in maintaining a stable marginal utility of money over time. Understanding marginal utility and how savings enhance it can provide useful insights on optimizing economic utility and satisfaction. This article explores the marginal utility meaning, factors affecting it, and how savings can increase the marginal utility derived from money.

What is marginal utility?
 

Marginal utility refers to the additional satisfaction or benefit a consumer gains from having additional units of a product or service. It describes how much extra utility is provided by an increase in consumption. For example, the marginal utility of the fourth apple eaten is lower than that of the 1st apple.

Initially, as you start saving, the marginal utility is typically high because each additional unit of savings contributes significantly towards achieving your financial goals or securing your future. For instance, the first few thousand rupees saved might go towards building an emergency fund or paying off debts, providing a sense of security and relief.

However, as your savings increase, marginal utility tends to decrease. This is because the additional units saved might not have as significant an impact on your financial situation as compared to earlier savings. At this stage, marginal utility might diminish to the point where the satisfaction gained from saving more becomes minimal.

The concept of marginal utility of money is attributed to the 19th century economist Alfred Marshall. It plays a key role in explaining consumer behaviour and the value placed on different units of a commodity.

Types of marginal utility
 

1. Positive marginal utility: Positive marginal utility occurs when saving an additional unit of money increases overall satisfaction or financial well-being. For example, saving money for a specific goal like a vacation or retirement can bring a sense of accomplishment and security, thus providing positive marginal utility.
2. Neutral marginal utility: Neutral marginal utility in savings happens when saving an additional unit of money neither significantly increases nor decreases overall satisfaction. This might occur when saving for routine expenses or when adding to an emergency fund that already provides a sense of financial stability.
3. Negative marginal utility: Negative marginal utility arises when saving an additional unit of money decreases overall satisfaction or financial well-being. This could occur if excessively tight budgeting leads to sacrificing essential needs or experiences, thereby reducing overall happiness despite having more savings.

Examples of marginal utility
 

Imagine you are saving for a vacation. Initially, each rupee saved adds significant excitement and anticipation, enhancing your overall satisfaction—a clear example of positive marginal utility. However, as your savings grow, the incremental joy from each additional rupee saved diminishes, reflecting diminishing marginal utility. Eventually, if you save excessively beyond your needs, sacrificing present enjoyment or necessities, it could lead to negative marginal utility, reducing overall happiness despite having more savings.

Characteristics of marginal utility
 

Marginal utility declines as more units are consumed. This is called the law of diminishing marginal utility. Marginal utility of money represents the utility gained from the last or marginal unit consumed rather than the total utility. It highlights the satisfaction from an additional unit, not the overall utility. Marginal utility helps explain consumer preference for variety rather than more of the same item due to declining marginal utility. It guides consumer spending decisions within a limited budget by comparing marginal utilities. 

Factors affecting marginal utility

• The rate of consumption - Consuming units of a product faster leads to declining marginal utility.
• Time - The marginal utility for a commodity may increase after some time gap following an initial period of high consumption.
• ndividual preferences - The utility gained varies across individuals based on their personal tastes and preferences.
• Availability of substitutes - The presence of close substitutes for a product lowers its marginal utility for consumers.
• Budget - Higher purchasing power and disposable income increases the marginal utility derived.

Marginal utility of money
 

Money has high marginal utility for low-income groups. Additional income makes a big positive difference to their lifestyle. For high-income groups, extra money adds relatively less utility at the margin due to diminishing returns. During financial hardship or emergency situations, the marginal utility of money rises sharply for individuals. Windfall gains like lottery winnings have lower marginal utility compared to money earned through one's efforts.

Savings increase marginal utility of money
 

Savings create a larger disposable income pool. Higher availability of money increases its marginal utility. Savings can absorb income shocks during adversities, preventing sharp falls in disposable income. This stabilizes the marginal utility of money. They enable meeting big ticket expenses like children’s education fees through lump sum payments, which have higher utility. When income falls suddenly, like job loss, savings help maintain consumption providing utility. Overall, savings make the marginal utility curve flatter and more stable over time.

How to raise marginal utility of savings?
 

• Building an emergency corpus to handle contingencies without income drops to maintain utility.
• Maintain health insurance to prevent medical spends from eroding savings.
• Invest savings to earn inflation-beating returns rather than leaving the money idle.
• Avoid temptation-spending from savings for short-term happiness spikes that reduce utility.
• Periodically review savings and financial goals to identify any shortfall, requiring course correction.
• Open a savings account that offers high interest rates and charges minimal fees to help grow your savings quickly.