limitations of marginal utility theory and its assumptions of rational behaviour

Utility – A‑Level Economics (9708)

1. Total Utility (TU) and Marginal Utility (MU)

• Total Utility (TU): the overall satisfaction a consumer derives from consuming a given quantity of a good.
  In the Cambridge framework utility is treated as an ordinal concept – the numbers are only a pedagogical aid to show the ranking of bundles.
  Mathematically (for illustration): TU = Σ Ui where Ui is the utility from the i‑th unit.
• Marginal Utility (MU): the additional satisfaction obtained from consuming one more unit of a good.
  Formula: MU = ΔTU / ΔQ.
  In the table below ΔQ = 1, so MU is simply the change in TU between successive quantities.

Worked‑out example (single good)

2. The Law of Diminishing Marginal Utility

• All else being equal, the marginal utility of a good falls as the quantity consumed rises.
  Reason: the most‑desired units are consumed first; each additional unit satisfies a less urgent want.
• A consumer will buy an extra unit only if the extra utility it provides is at least as great as its price: MU ≥ P.
• Because MU falls with each extra unit, the equality MU = P is reached at a lower quantity when the price is higher.
  Plotting price (P) against the quantity demanded (Q) therefore gives a **downward‑sloping individual demand curve**.

3. The Equi‑Marginal Principle (Utility Maximisation)

When a consumer purchases several goods, the budget is allocated so that the last unit of money spent on each good yields the same marginal utility per pound (or per euro, etc.). This is the **equi‑marginal principle**:

MU_A/P_A = MU_B/P_B = … = MU_n/P_n

subject to the **budget constraint**:

PA·QA + PB·QB + … = Budget

Numeric illustration (two goods, budget £10)

Spending the remaining £2 on a third unit of Good A would give MU/P = 5, which is lower than the MU/P = 6 of the last unit of Good B. Therefore the consumer reallocates one unit of money from Good A to Good B, ending with:

• Good A: 2 units (MU/P = 7.5)
• Good B: 4 units (MU/P = 6)

Now the marginal utility per pound is equalised across the two goods, so total utility is maximised given the budget.

4. Deriving an Individual Demand Curve from Utility Maximisation

1. For a given price, apply the condition MU = P using the MU schedule.
2. Identify the quantity at which MU just equals the price (the last unit that satisfies MU ≥ P).
3. Repeat for a range of prices.
4. Plot the resulting (P, Q) pairs – the points lie on a downward‑sloping demand curve (see Figure 2).

Price‑quantity table (derived from the MU schedule above)

Connecting these points produces the familiar downward‑sloping individual demand curve (Figure 2).

5. Assumptions of Rational Behaviour Underlying the Theory

• Utility maximisation: consumers choose the bundle that gives the highest total utility within their budget.
• Complete preferences: any two bundles can be ranked as preferred, indifferent, or less preferred.
• Transitive preferences: if A > B and B > C, then A > C.
• Convex (diminishing) preferences: consumers prefer diversified bundles; MU falls as quantity rises.
• Stable preferences: preferences do not change during the period of analysis.
• Perfect information: consumers know all relevant prices, qualities and their own preferences.

6. Limitations of Marginal‑Utility Theory

6.1 Empirical Limitations

1. Measurement problem: because utility is ordinal, it cannot be measured in absolute units, making empirical testing difficult.
2. Non‑monetary or status goods: for luxury or Veblen goods the law of diminishing MU may not hold; higher consumption can increase perceived utility.
3. Behavioural anomalies: habits, addictions, and bounded rationality often lead consumers away from strict utility maximisation.

6.2 Theoretical Limitations

1. Full rationality assumption: ignores cognitive biases, emotions and heuristics that affect real‑world choices.
2. Static framework: analyses a single decision point, overlooking intertemporal choices and expectations about future prices or income.
3. Independence of Irrelevant Alternatives (IIA): the theory assumes that adding a new option does not change the relative preference between existing options, which is often violated (e.g., attraction or decoy effects).
4. Homogeneous preferences: treats all consumers as having the same preference structure, disregarding cultural, social and demographic influences.
5. Behavioural‑economics perspective: research on bounded rationality, prospect theory and heuristics shows that many consumers “satisfice” rather than maximise utility.

7. Summary Table – Assumptions vs. Limitations

8. Suggested Diagrams (for exam revision)

• Figure 1 – Total Utility and Marginal Utility curves: TU rises at a decreasing rate; MU falls continuously, illustrating the law of diminishing marginal utility.
• Figure 2 – Derivation of the individual demand curve: Plot the (P, Q) points obtained from the MU = P condition and connect them to show the downward‑sloping demand curve.

9. Concluding Remarks

Marginal‑utility theory offers a coherent, mathematically tractable framework for understanding how a rational consumer allocates limited resources. It links the law of diminishing marginal utility to the shape of the demand curve and to the equi‑marginal principle. Nevertheless, the theory rests on strong rationality assumptions and on an ordinal notion of utility that cannot be measured directly. These features give rise to notable empirical and theoretical limitations. Recognising these limits equips students to answer A‑Level exam questions critically and to appreciate alternative approaches—especially behavioural economics—that better reflect real‑world decision‑making.