Utility describes a consumer's satisfaction or happiness. Economists often find it convenient to measure utility using dollars to describe the price consumers place on goods or experiences. This measure fails in many cases, such as in measuring the utility people get from dollars themselves. In these cases, economists use imaginary units, called utils. Conventional logic suggests that as a consumer makes more money, each individual extra dollar brings less additional happiness. This law of diminishing marginal utility states that the marginal utility of income drops continuously as income rises.
1. Obtain or estimate a relationship between an individual's income and utility. For example, a person may have a utility function relating u, their utility, and i, their income, according to u = 50√i.
2. Calculate the individual's utility at a base income. For example, if the individual initially has an income of $40,000, then calculate 50 × √40,000 = 10,000 utils.
3. Calculate the individual's utility at an income of $1 more than the base income: 50 × √(40,000 + 1) = 10,000.125 utils.
4. Find the difference between these two values: 10,000.125 - 10,000 = 0.125 utils. This is the individual's marginal utility of income at $40,000.
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