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Summary: In economics, the concept of marginal utility refers to the satisfaction that a consumer derives, upon consuming additional units of a product or a service. But what does it have to do with one’s savings? Learn how marginal utility and savings are intertwined.
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.
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.
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.
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.
Marginal utility also influences the demand curve and price determination of a commodity.
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 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.
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