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Law of Diminishing Marginal Utility

A major concern in the theory of consumer behaviour is to find consumer’s equilibrium

i.e., consumer’s maximum satisfaction within given conditions.

Consumer’s equilibrium can be discussed under the following three approaches:

At present, we are concerned with the law of diminishing marginal utility which provides the sound foundation to discuss consumer’s equilibrium under the cardinal utility approach.

The pivot of the law under discussion is the concept of marginal utility.

By marginal utility we mean net addition to the total utility due to consumption of an additional unit of a particular good or service.

Mr. Gossen, a German economist, was the first to explain this law in 1854. Later Alfred Marshall (1842-1924) refined this law and is considered the major exponent of this law.

Related Statements

Dr. Alfred Marshall in his book “Principles of Economics” states that:

“The additional benefits which a person derives from an increase of his stock of a thing diminish with every increase in the stock he already has.”

Paul A. Samuelson says that:

“As the consumed amount of a good increases, the marginal utility of that good ends to decrease.”

Comprehensively Speaking

Law of diminishing marginal utility states that:

“Other thing being constant, marginal utility of a particular good or service continues to decrease with its consecutive consumption; it reaches zero and if consecutive consumption of successive units is continued, it becomes negative.”

ASSUMPTIONS

Law of diminishing marginal utility is valid only with the following assumptions.

Rationality

The basic assumption is that the consumer aims at maximization of satisfaction within given conditions.

Constant Marginal Utility of Money

Purchasing power per unit of money for successive units of money remains the same.

Additive Utility

Additive utility  implies independent utilities of various goods in a given bundle which can be added to find total utility. If there are n commodities in a bundle with the quantities x1, x2…………..xn, then utility function is

U = f (x1, x2, ………….xn)

Here total utility is additive, i.e.,

U = U1 (x1) + U2 (x2) + …………… + Un (xn)

Homogeneous Units

All the successive units to be consumed must be homogeneous in all respects i.e. size color, packing etc.

Suitable Quantity

Suitable units of a commodity should be consumed otherwise this law will not be valid.

No Change in Consumer’s Attitude

Consumer’s attitude towards a commodity should remain the same.

No Change in Taste

This law will not be valid if there is a change in taste or fashion.

No Change in Quality

Quality of successive units should be the same. For example, if quality of successive units improves, this law will not be valid.

No Change in Price

In case of decrease in price, utility may increase for the successive unit. Thus price should remain the same for the validity of this law. Moreover, the price of substitutes should also remain the same.

No Change in Income

Change in consumer’s income brings about a change in purchasing power which may change the whole scenario. Hence consumer’s income should remain the same.

Divisibility

Commodity consumed should be divisible into smaller units.

FRAMEWORK

We can illustrate this law with the help of the following table and diagram:

Units of goodTUMU
11010
2188
3224
4220
516– 6

The table shows that with the consecutive consumption of successive units of the given particular commodity, marginal utility decreases. If this practice carries on, a consumer reaches the saturation point at the consumption of the 4th unit.

Here total utility is maximum while marginal utility is zero. The consumption of the 5th unit shows that if consumption is continued even after the saturation point, marginal utility becomes negative and total utility decreases.

Now we construct the following diagram which also explains this law.

The diagram shows that MU curve has negative slope which reveals that MU decreases as the consecutive consumption of successive units of the given commodity increases. It reaches zero at 4th unit and it becomes negative if consumption is continued even after the saturation point at the consumption of 4th unit.

Thus both the table and the diagram confirm law of diminishing marginal utility.

EXCEPTIONS / LIMITATIONS

We observe the following exceptions or limitations of law of diminishing marginal utility.

Money and Wealth

The temptation of money and wealth has no end.  This law is not applicable on money and wealth.

Knowledge

If a person acquires more and more knowledge, his thrust for knowledge increases and the utility of further study also increases.

Art

It has never been perfections in art and a true artist always remains ambitious towards the perfection.

Rare Collections

This law does not hold in case of collection of antiques like diamonds, old coin, rare paintings etc.

Power

This law does not hold for power and its externalities.

Taste for Display

This law does not apply to things or activities which satisfy a consumer’s taste for display of wealth or prestigious status in the society.

Public Goods

This law is not applicable in case of public goods as the utility of public goods like telephone facility goes on increasing .

Hobbies

This law does not hold for personal hobbies like painting, gardening, ticket collecting etc.

Addictions

If a person is addicted, his utility for successive units increases. Hence this law does not apply.

Fashion and Customs

This law becomes inoperative in case of fashion and customs.

CRITICISM

Same demerits as discussed under law of equi-marginal utility.

Importance

Law of diminishing marginal utility is considered very important in Economics literature on the basis of the following facts:

Basis of the Law of Demand

Law of diminishing marginal utility (LDMU) provides the basis of the law of demand. When we have higher stock of a commodity, its MU decreases and when MU decreases, price of the good decreases which results in higher demand.

Consumer’s Equilibrium

It provides sound foundation to meet ultimate objective of a consumer, i.e. maximum satisfaction within given conditions.

Consumer’s Surplus

Consumer’s surplus is the difference between the price which he is willing to pay and what he actually pays. It is basically the difference between the total utility and the actually money spent. Thus the concept of consumer’s surplus is based on LDMU.

Taxation Policy

LDMU reveals that MU of money for rich is less than the poor. The finance minister seeks help from this law and imposes progressive tax, in which higher rate of tax is imposed on the rich and lower rate of tax is imposed on the poor.

Redistribution of Wealth

Marginal utility of money for the rich is lower than for the poor. If some wealth is taken away from the rich minority and distributed among the poor majority, total utility of the society increases. Hence LDMU provides an inducement for redistribution of wealth.

Price Determination

If supply of a good increases its MU decreases and as a result, price also decreases. Hence price is determined in the light of this law

Value in Exchange

Value in exchange is determined on the basis of the concept of marginal utility. For example, air has value in use but no marginal utility and as a result no price. On the other hands the goods which have MU, these goods have value in exchange.

Household Expenditure

A rational household settles his expenditures in the light of LDMU. He does not spend even a single penny on the good from which MU is less than price of that good.

Variety in Production

Marginal utility of one product decreases sharply while the marginal utility of variety of products decreases slowly. Hence this law iduces the producers to supply a variety of commodities in the market.

CONCLUSION

The above discussion reveals that LDMU is one of the basic laws of Economics literature. It provides foundation stone for consumer’s equilibrium under a classical approach.

Moreover, many other very important economic theories developed on the basis of this law

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