(a) Explain the concept of diminishing marginal utility. (b) How is utility maximized?

Answer Details

(a) Diminishing marginal utility. Utility is the satisfaction a consumer gets from consuming a good. Marginal utility is the extra satisfaction from consuming one more unit. The law of diminishing marginal utility states that as a consumer takes in successive units of a good within a given period, the extra (marginal) satisfaction from each additional unit falls, other things being equal. For example, the first cup of water to a thirsty person gives high satisfaction, the second less, and later cups very little or even negative satisfaction. Total utility still rises while marginal utility is positive, reaches a maximum when marginal utility is zero, and falls when marginal utility becomes negative.

(b) How utility is maximised. A rational consumer with a fixed income and given prices maximises satisfaction by allocating spending so that the last naira spent on each good yields the same marginal utility. This is the equi-marginal principle: consumption is adjusted until

\[ \frac{MU_x}{P_x} = \frac{MU_y}{P_y} = \frac{MU_z}{P_z} \]

where \( MU \) is marginal utility and \( P \) is price of each good. If the ratio for one good is higher, the consumer gains by buying more of it (its marginal utility falls) and less of another, until the ratios are equal and total utility can no longer be increased by any reshuffle of spending.