Unit 2, Lesson 4

Utility and the Law of Diminishing Returns

AOFBusiness Economics

“Too much of a good thing” is an economic concept

• Why does a cold drink taste so good after playing sports?

• Why doesn’t the second drink taste quite as good as the first?

• And the third even less appealing?

• And the fourth? Not unless you want to get sick.

Picture of Sweaty Basketball player drinking

The answers are utility, marginal utility, and diminishing marginal utility.

Economics measures the value a good provides

• Marginal Utility: The amount of value one more instance of an item will give us

• Diminishing Marginal Utility:The decline in the amount of value each additional instance of an item brings when consumed in a given time period

• Total Utility:The sum of all value gained from the consumption of all instances of an item

Gatorades Consumed

Marginal Gatorade Utility

Total Gatorade Utility

0 $ 0 0

1 $ 1.59 $ 1.59

2 $ 0.99 $ 2.58

3 $ 0.10 $ 2.68

4 $ 0.02 $ 2.70

5 $ 0 $ 2.70

At a certain point, consuming more of something provides no extra benefit

12

34

5

Marginal GatoradeUtility

$1.59

$2.58$2.68 $2.70

$2.70

$1.59

$0.99

$0.10$0.02

$-

$-

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

Value of Next Drink

Number of Drinks Consumed

Sports Drink Diminishing Marginal Utility

Utility can help businesses make decisions

• Gatorade factory tries to produce the right amount of Gatorade to satisfy the thirsty kids’ wants.

• It wants to do this while earning as much money as possible.

• So how many workers should the factory hire?

• If you hire too many and produce too much, the price could !