Marginal Utility: Marginal utility is the additional utility derived by an individual from the consumption of one or more unit of a commodity. Marginal utility denotes the change in the total utility due to the change in quantity consumed of commodity. Marginal utility influences and regulates the price determination of a commodity. This may be explained by the following table.
How Does Marginal Utility Determine Price:
|Total Utility of Money|
The above table shows the consumption behavior of an individual. A consumer is willing to spend USD.1 for purchasing a mango. He gets 20 utils of Marginal Utility from the consumption of the first mango. Since he is hungry and since his desire for mangoes is great, he finds it worthwhile to spend USD.1 on the first mango. As his desire was satisfied to some extent, he prefers to pay a less amount of price namely 75 cents for the second mango. The second mango gives him 15 utils of marginal utility. He spends 50 cents and 30 cents for Purchasing 3rd and 4th unit of the mangoes respectively. As his desire for mangoes is diminishing, he considers it better to spend less amount of money for their purchase. Consequently the marginal utility derived from the 3rd and 4th mangoes remains less at 12 and 8 utils respectively. Hence marginal utility influences and determines the price of a commodity. The price of a commodity is proportional to the marginal utility. The higher the marginal utility, the greater will be the price paid by a consumer.
Paradox of Value (Gold water or Diamond water Paradox) :
The Law of Diminishing Marginal Utility is the basis of the paradox of value. It is the marginal utility that determines the value-in-use and value-in-exchange of a commodity. Water has greater value in use. On the other hand, diamond or gold has greater value-in-exchange. Water has no greater value-in-exchange and diamonds and gold have no greater value-in-use. This difference between value-in-use and value-in-exchange is found due to the differences in the marginal utilities and prices of the two commodities.
Marginal utility is the determinant of price. Whether commodity has great or less marginal utility depends on its supply. If the supply of a commodity is limited and scarce when compared to demand, then the marginal utility and price of that commodity remain high. That is why gold and diamonds possesses greater marginal utilities. On the other hand, if the supply of a commodity is limited in relation to its demand, it has lesser price and less marginal utility. Water is an example of this type. Water has great value-in-use and less value-in-exchange. Its marginal utility is less due to its unlimited availability. Hence the concept of marginal utility is used for explaining the diamond water paradox or paradox of value.