Economics

The Law of Diminishing Marginal Utility – A Complete Guide

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility is the basic law of consumption. It explains the common experience of the consumers. It is based on one of the characteristics of human wants which states that though human wants are unlimited, each want is satiable. We can satisfy any want at a particular point of time.

Let us suppose that an individual is hungry. Let us further suppose that he was provided with apples. As he goes on consuming one apple after another, he gets complete satisfaction after the consumption of some apples, say, five apples. But the utility derived by him from successive units will decrease with every increase in the stock of the commodities. He hesitates to eat apples after the point of satiety. So the consumption of more and more apples bring less and less utility for the consumer. This is same in the case of all rational consumers.

Herman Henrich Gossen, a German economist was the first person who propounded this Law of Diminishing Marginal Utility in 1854. He stated this law as follows:  “The magnitude of one and the same satisfaction, when we continue to enjoy it without interruption continually decreases until satisfaction is reached“. Jevons described this law as Gossen’s first law of consumption. Later on, Marshall stated and developed this law on scientific basis.

Statement of the Law of Diminishing Marginal Utility:

Marshall stated the Law of Diminishing Marginal Utility the following way. “The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has“. Boulding stated this law as follows : “As a consumer increases the consumption of any one commodity keeping constant the consumption of other commodities, the marginal utility of the variable commodity must eventually decline”.

Illustration of the law of diminishing marginal utility:

The Law of Diminishing Marginal Utility is illustrated with the help of the following table and diagram

Quantity of Mangoes Marginal Utility (MU) Total Utility (TU)
1 20 Utils 20 Utils
2 18 Utils 38 Utils
3 15 Utils 53 Utils
4 11 Utils 64 Utils
5 6 Utils 70 Utils
6 0 Utils 70 Utils
7 -8 Utils 62 Utils
8 -16 Utils 46 Utils
Illustrative  Table : The Law of Diminishing Marginal Utility

In the above table, it is assumed that the consumers is taking mangoes one after another. Marginal Utility is the utility obtained by a consumers from the consumption of additional unit of a commodity. Total utility is the utility obtained from a given quantities of a commodity. It is the total of all the marginal utilities. It is clear from the above Table that the consumer gets less and less utilities as he consumes more and more mangoes. The first mango gives him 20 utils of satisfaction. The second unit gives 18 utils. The marginal utility diminishes when he consumes more and more units. The total utility increases at a diminishing rate.

When the consumer takes 5th unit, his total utility and marginal utility are 70 utils and 6 utils respectively. Marginal utility is zero at 6th mango. It means that the consumer attained the level of satisfaction or satiety at this unit. If he takes 7th mango, it gives him negative utility. He hesitates to take 7th and 8th mangoes. Here total utility decreases and marginal utility become negative. The Law of Diminishing Marginal Utility can also be illustrated by means of the following diagrams :

Law of Diminishing Marginal Utility

As shown in the above, the top diagram indicates the nature and slope of Total Utility curve. It is an upward sloping curve. At first its rise is considerably high. Later on, it increases at a diminishing rate. Lastly, it slopes downwards denoting a rapid fall in total utility of the consumer. Bottom diagram shows the nature and slope of marginal utility curve. Marginal utility curve slopes downwards from left to right. It intersects the OX at a point when total utility curve is at its highest point. It remains negative when total utility curve slopes downwards. The diminishing marginal utility curve indicates the fall in the marginal utility derived by all individual consumer with every addition in his stock of the commodity.

Causes Of Downward Slope Of Diminishing Marginal Utility Curve :

Diminishing Marginal utility curve slopes downwards from left to right due to two causes which are explained below.

1 . Each want is satiable: It is assumed that individuals can’t satisfy all their wants. But they can satisfy a particular want completely. The additional utility from the successive units of the commodity decreases and remains zero at the level of satiety. Hence marginal utility curve slopes downwards.

2. Imperfect substitutes: If a commodity has perfect substitutes, its marginal utility may not diminish. Similarly, if a commodity is used for satisfying different kinds of wants„ its marginal utility remains the same and will not diminish. But in practice goods which have close and perfect substitutes are less rather rare in number. As a result a particular good is used for satisfying particular want only. Therefore utility derived from additional units diminish and marginal utility curve slopes downwards from left to right.

Law of Diminishing Marginal UtilityAt first Marginal Utility Curve rise considerably high. Later on, it increases at a diminishing rate. Lastly, it slopes downwards denoting a rapid fall in total utility of the consumer. Marginal utility curve slopes downwards from left to right. It intersects the OX at a point when total utility curve is at its highest point. It becomes negative when the total utility curve slopes downwards. The diminishing marginal utility curve indicates the fall in the marginal utility derived by all individual consumer with every addition of the commodity.

Assumptions and Limitations of the Law of Diminishing Marginal Utility :

Marshall and other economists enunciated and developed the Law of Diminishing Marginal Utility on the basis of certain assumptions. These assumptions are also described as the limitations or the conditions of this law.

1. No time gap: The Law of Diminishing Marginal Utility holds good only when the consumers consume the different units of a commodity within a certain time frame. Otherwise it is not applicable. For example, a consumer takes apples one after another. His marginal utility of apples diminishes with every increase in his consumption. On the other hand, if he takes one apple in the morning, another in the afternoon and the third in the evening, his desire for mangoes or apples, instead of diminishing, would increase.

2. Homogeneous Units: The units of a commodity to be consumed should possess homogeneous features in form, size, taste, color and quality. Suppose big and small units, sweet and sour mangoes are selected for consumption purposes, the marginal utility increases instead of diminishing

3. Constant income: There should be no change in the income of the consumers. Any change in the income affects the consumption behavior of the consumers. When the consumer’s income increases, he may think of revising his consumption pattern abruptly. He may change his opinion regarding the consumption of various commodities.

4. Standard Units: According to the The Law of Diminishing Marginal Utility, the unit taken for consumption purposes must be of standard one. They should be neither too large nor too small. Suppose people take coffee by using cups. If they take coffee in small spoons, the utility of marginal units will increase. So the units of a commodity must be given to the consumers in standard sizes.

5. Normal persons: The Law of Diminishing Marginal Utility is based on the assumption that the consumer behaves in a rational way. It is not applicable in the case of eccentric or abnormal persons like misers who behave in an irrational way.

6. Constancy in price: The Law of Diminishing Marginal Utility assumes that there are no changes in the price of a commodity and its substitutes. The law does not operate when there is a change in price.

7. Changes in other people’s stock: Another assumption of this law is that there should be no change in the stock of others. A change in the stock of others affects the utility of the consumer. For example the value and utility of land of an individual increases when large scale and medium scale industries were established in a town.

8. Divisible goods: The Law of Diminishing Marginal Utility is applicable to divisible goods only. Durable and indivisible goods like cars, televisions, video cassette recorders, scooters etc, do not come under the purview of this law. The reason is that their utility is spread over a period of time. Normally no one buys another new car or television immediately after his first use.

9. Other possessions: This law assumes that there should be no change in the possession of the complementaries by an individual. It ignores the Law of complementarity. For example, a horse without a carriage or a car without petrol is of no use. But if we can  acquire a horse or a car, their utility increases.

10. Fashions: This law also assumes that people’s fashions the same. Changes in fashions influence the marginal utility of the consumer. If we have a fashionable dress, its utility increases. On the other hand, if our shirt is out of fashion, its utility decreases.

11. Ordinary goods: The Law of Diminishing Marginal Utility applies only in the case of ordinary goods. It is not applicable to extra ordinary goods like diamonds, pearls etc.

12. Tastes and preferences: This law assumes that no change occurs in the tastes and preferences of the consumer during the consumption process. So this law does not apply when people’s tastes and preferences change.

13. Marginal utility of Money: This law assumes that marginal utility of money remains constant. If the marginal utility of money changes, the law does not operate. Thus Law of Diminishing Marginal Utility is based on several assumptions and limitations. It is applicable only when the above conditions prevail.

Marshall and other economists enunciated and developed the Law of Diminishing Marginal Utility on the basis of the above  assumptions.

Practical Importance  Of Law Of Diminishing Marginal Utility

1. Taxation : This law is the basis of progressive taxation. As a person’s income increases, the rate of tax rises because the marginal utility of money to him falls down with arise in his income.

2. Price Determination: This law also acts as the basis of the theory of value. It explains the reasons for the decrease in the value of a commodity due to an increase in its supply.

3. Household expenditure: The Law of Diminishing Marginal Utility influences our day-to-day household expenditure. We avoid the purchase of a commodity when its marginal utility equals its price.

4. Downward sloping demand curve : The downward sloping demand curve is originated from this law. As marginal utility of a commodity falls due to an increase in its stock, demand for it also decreases. As a result the demand curve takes downward sloping form.

5. Value-in-use and Value-in-exchange : The Law of Diminishing Marginal Utility also explains tile difference between value-in-use and value-in-exchange. Air has great value-in-use but it has little value-in-exchange. Diamonds have great value-in-exchange but they have little value-in-use.

6. Redistribution Of Wealth: This law is advocated by the supporters of socialism who consider it proper to impose more taxes on the rich and less on the poor for redistributing the available national wealth.

7. Variety in consumption : The Law of Diminishing Marginal Utility explains the need for consuming a variety of commodities for the welfare of the consumers.

The Law of Diminishing Marginal Utility is based on fact that human wants are unlimited. Even though this law is considered a universal one, it has the following exceptions.

Exceptions Of The Law Of Diminishing Marginal Utility

1. Collection of rare goods: This law is not applicable in the case of rare goods. Persons, who collect rare goods like ancient pictures, stamps, coins, antiquities etc., get more utilities when they collect more rare goods.

2. Abnormal persons: The Law of Diminishing Marginal Utility is not applicable in the case of abnormal and eccentric persons like drunkards, gamblers, and misers. These persons develop a fascination and became slaves to their habits. A drunkard feels that he gets more utilities with the consumption of more liquor. Similarly, the utilities of a miser increases with a rise in his collection of money. Music lovers also get more utilities when they heard music for longer hours.

3. Not applicable to money: It is argued that law of diminishing marginal utility is not applicable to money. Normally people get more utility and happiness when they acquire more money. As possession of money is a symbol of prestige and dignity, people incline to earn more money. So their utility increases with every increase in money.

 The Law of diminishing Marginal utility is considered a suitable one for explaining some economic problems and tor formulating  certain economic policies. The significance  of Law of diminishing Marginal utility in Economics is explained as follows:

Significance Of Law Of Diminishing Marginal Utility

The Significance Of Law Of Diminishing Marginal Utility can be discussed under the following header-

1. Paradox of value : The Law of Diminishing  Marginal Utility has great significance in explaining the paradox of value or gold-diamond  paradox. This law emphasizes the fact that marginal utility of a goods will be less when its supply is abundant. It also points out the fact that goods like water, salt etc, have use-value only. The exchange value of these abundant goods is little or dismal. Goods like mercury, gold, diamonds etc. have more, value in exchange and less value-in-use. People desire to buy diamonds on the grounds of dignity and prestige. As a result the marginal utility of these goods remain less. This is known as the diamond water paradox.

2. Redistribution of income : Marginal Utility of money decreases with every increase in the level of income. The marginal utility of money for the rich people  is less when compared to that of the poor. So redistribution of income from the rich to the poor promotes the overall welfare of the people. Economic inequalities can be eliminated and social justice can be achieved through the redistribution of income in the society. In this connection the law of Diminishing Marginal Utility acts as a basis for devising steps for redistribution income.

3. Progressive Taxation : The concept of progressive taxation is based on Law of Diminishing Marginal Utility. Rich people do not feel burdensome when they are imposed with more taxes as their marginal utility for money is less. The more the income, property and wealth, the greater will he the incidence of taxation. The imposition of more taxes on rich people is justified on the ground that addition in their income brings less marginal utility.

4. Consumer’s equilibrium: The law equi marginal returns is based on the Law of Diminishing Marginal Utility. The marginal utility of a commodity decreases as its consumption increases. The consumer purchases different types of commodities by comparing marginal utilities derived from them.  For example, a consumer has to purchase commodity A and B. He compares the utilities of these two items and purchases one of the two commodities which yields more marginal utility. He spends his limited money on different goods by making comparison between the marginal utilities of the latter.

5. Law of Demand:  The law of diminishing marginal utility is the basis of the law of demand. The law of demand states that demand for a commodity is more when its price falls and vice-versa. This is due to the influence of the law of diminishing marginal utility. Marginal utility of a product decreases when its supply increases. So, the consumer purchases more of a goods when its price is less.

6. Price theory: The law of diminishing marginal utility is also considered the basis for the price theory. The price of a commodity falls when its supply increase and rises when its supply decreases. The reason is that people purchase more quantity of a good at lower prices as the marginal utility of additional stock is less.

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