The law of diminishing marginal utility is one of the most important laws of Economics. This law was first introduced by German economist Hermann Heinrich Gossen. Then the law was more developed and explained on a systematic manner by Alfred Marshall. Alfred Marshall stated this law as follows:
the additional benefit that a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has.
The law of diminishing Marginal utility is thought to be suitable for explaining a few economic problems and for formulating certain economic policies. The significance of the Law of diminishing Marginal utility in Economics is explained below:
Significance Of Law Of Diminishing Marginal Utility
The Significance of Law of Diminishing Marginal Utility may be discussed under the following grounds-
- Paradox of value: The Law of Diminishing Marginal Utility is important for explanation of the paradox of value or gold diamond water paradox. This law stresses on the fact that marginal utility of a goods will be less when its supply is plentiful. Furthermore, it points out the reality 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 want to buy diamonds on the grounds of dignity and prestige. Therefore, the marginal utility of these goods remain less. This is known as diamond water paradox.
- Redistribution of income: Marginal Utility of money declines with every increase in the level of earnings. The marginal utility of money for the rich people is less as 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 abolished and social justice can be achieved through the redistribution of income in the society. In this connection, this law acts as the basis for devising steps for redistribution income.
- Progressive Taxation: The theory of progressive taxation is based on the 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 be the incidence of taxation. The imposition of more taxes on rich people is justified on the ground that addition in their earnings brings less marginal utility.
- Consumer’s equilibrium: The law equi-marginal returns is based on this law. The marginal utility of a commodity declines as its consumption increases. The consumer buys various types of goods by comparing marginal utilities derived from them. For example, a consumer has to purchase goods A and B. He compares the utilities of these two items. He purchases one of the two goods which yield more marginal utility. He spends his limited money on different goods by making comparison between the marginal utilities of the latter.
- Law of Demand: This law is the basis of the law of demand. The law of demand denotes that the demand for commodity is high when its price is less and vice-versa. This is due to the influence of the law of diminishing marginal utility. Marginal utility of a product declines when its supply increases. So, the consumer purchases more of goods when its price falls.
- Price theory: The law of diminishing marginal utility is also regarded as the basis for the price theory. The price of a commodity decreases when its supply increases 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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