In economics you are often required to calculate the marginal utility
per dollar spent during the consumer theory or the utility theory portion of
the class. The calculation is easy, as you only need to divide the marginal
utility of a good or service by the price of that good or service. If you do
not have the marginal utility of the good or service, then you need to figure
it out by looking at the difference between total utility amounts at different
levels of consumption (see this link for help on calculating marginal values—and
also see the example below). The idea behind calculating marginal utility per
dollar spent is to find out how effective you are while allocating your budget.
For example, if a marginal utility per dollar spent is higher for one good than
it is for another good then it means that you are not allocating your budget
efficiently. In order to allocate your
budget efficiently, you need to have the marginal utility per dollar spent for
every good and service be equal to each other.
For example, imagine you are trying to
allocate your budget between two goods: apples and oranges. Suppose that the marginal utility of the last
apple consumed is four. And that the
marginal utility of the last orange consumed was three.
MU(apple)=4
MU(orange)=3
At first it would seem like the apple is
preferred to the orange, but this is not true.
We still need information about the prices of each of the goods. Now imagine that the price of an apple is
$2.00 per apple, and that the price of an orange is only $1.00.
Price of apply = $2
Price of orange = $1
We can figure out what the marginal
utility per dollar spent is by taking the marginal utility and dividing by the
price. This will give us a marginal
utility per dollar spent on an apple as two utility per dollar spent, where the
orange has three utility per dollar spent.
Marginal Utility per Dollar Spent =
Marginal utility divided by price = MU/P
MU/P of apple = 4/$2 = 2
MU/P of orange = 3/1 = 3
This means that an orange has a higher
marginal utility per dollar spent. Therefore
an additional budget dollar should be spent on the orange. As more budget dollars are spent on the oranges
you would expect the marginal utility of the orange to drop, and continue
dropping until the marginal utility of the orange decreases from 3 to 2. If the marginal utility of an orange changes
to two, then the marginal utility per dollar spent of an orange would become two. At this point the marginal utility per dollar
spent on both apples and oranges would be equal to two and it means that we are
using our budget efficiently (by maximizing our utility given our budget). Whichever good has a higher marginal utility
per dollar spent, is the good that we should consume more of that good until
the marginal utility decreases to the point at which they're both equal.
