Many people assume that the study of economics is all about money, but it is actually more focussed on the choices that households, firms and governments make. There is significant debate over the motives behind the decision-making process. Are we truly rational creatures, or are we influenced by a broad range of biases?
Traditional economic theory contends that humans are rational beings that aim to maximise the satisfaction gained from consuming goods and services. The technical term for this “satisfaction” is utility. Total utility is the satisfaction gained from consuming all units, while marginal utility measures the additional satisfaction from consuming just one more unit. The law of diminishing marginal utility says that the more units of a good that are consumed, the lower the utility from consuming those additional units.
Marginal utility theory is key to economic decision-making, as rational individuals will only consume a good or service up to the point where the price equals the marginal utility (assuming we can measure “utils” in pounds and pence). If price is lower than marginal utility, the additional benefit to the consumer is greater than the cost of purchase, so continuing consumption is rational. Once price is higher than marginal utility, making the purchase would be irrational.
This decision making process and the concept of utility is perfectly explained in this superb video:
Add comment
Comments