Law of Diminishing Marginal Utility

Economics

What is the Law of Diminishing Marginal Utility (Gossen’s First Law)?

The law of diminishing marginal utility states that the utility derived from each additional good or service is less than the previous consumption of the good or service. In other words, the satisfaction gained from additional consumption goes on decreasing with each additional consumption of the same good.

Unlike total utility, the marginal utility may attain the value of zero or a negative amount when the utility becomes completely unfavorable for the consumer. This is an outcome of continuous consumption of a good. It implies that satisfaction is the highest while a consumer consumes the first good or service.

The satisfaction derived from second consumption is less than the satisfaction gained by first consumption. The marginal utility thus goes on decreasing with consumption of each additional consumption.

Law of Diminishing Marginal Utility - Assumptions

For the law of diminishing marginal utility to be true or hold good, some assumptions must be followed. In case the assumptions are neglected, the marginal utility function may get affected which means the law of diminishing marginal utility in such cases may not be appropriate.

  • The first assumption of the law is that the quality of the product that is considered for the diminishing marginal utility must remain the same in the case of all consumption.

If the quality of the good is altered, the utilities for two instances may not be compared and hence, the law may not be proven true.

  • The second assumption of the law is that the consumption of goods must be continuous.

If there is a substantial break between two consumptions, the utility derived from them may not be considered a marginal utility. In fact, a gap of a long time changes the desirability of the good which has to be consumed. Therefore, when a long gap is there between two successive cases of consumption, the law of diminishing marginal utility cannot be implemented.

  • The third assumption is that the consumer and the consumer’s mental outlook should remain the same for the given good or service.

If the person or his/her mental outlook is altered, the law of diminishing marginal utility may not hold good.

  • The fourth assumption is reloaded to the number of units. It is assumed in the case of the diminishing marginal utility that the units of the goods should neither be too small nor too big.

In the cases of too small or too big units, the measurement of marginal utility may suffer from misleading appropriation.

Examples of Diminishing Marginal Utility

There are many examples of diminishing marginal utility in our day-to-day lives.

Example 1

If we consider a set of ice cream scoops, the utility or satisfaction derived from consuming the first scoop is the highest. The satisfaction from the second scoop will be less than the first scoop. This will go on decreasing when there will be no satisfaction derived from a certain number of consumption of the ice cream scoops. Any additional consumption after this will give a negative value of satisfaction as the consumer will actually find it unfavorable to consume the ice cream scoops.

Example 2

The law of diminishing marginal utility can be related to diminishing pricing as well.

When a person has consumed one good at a certain price, he will tend to pay a lesser amount for the second good. This is so because the level of satisfaction from the second good is less than the satisfaction derived from the first. For example, if a person is willing to pay Rs 10,000 for a vacuum cleaner, he will pay this amount for the first one he buys. However, for the successive units of cleaners, he will not intend to pay Rs 10,000 but will only purchase if the price of the cleaner is decreased substantially.

Example 3

Another example of marginal utility is related to the availability of the product and its use.

The example of gold and slices of bread shows the concept of diminishing marginal utility as well. It is observed that at any instance the price of gold is more than the slices of bread even when the latter is more important for life. It is so because slices of bread are easily available and the consumers consume them enough so that the satisfaction derived from slices of bread is zero in most cases. In the case of gold, however, it is a scarce product and people do not buy enough gold in their lives. Therefore, the price of slices of bread is lower than the price of gold.

Use of Diminishing Marginal Utility

Progressive Taxation

The tax system usually leaves more burden on the shoulders of the rich while less tax is attached to the income of the poor. The poor people have less money, so their demand for money is more for them. The rich, on the other hand, has no trouble bearing a greater burden because the value of money is less for them. The additional resources offer less burden to the rich and so they do not mind losing more money as taxes.

This is how the progressive taxation system works.

Determination of Price

The law of diminishing marginal utility helps in deriving the prices of goods in the market. When an individual buys an additional good he/she is willing to pay less for the additional good. The sellers, therefore, reduce or determine the prices depending on the law of diminishing marginal utility.

This is how the law of diminishing marginal utility plays a crucial role in the determination of goods and services.

Optimum Utilization of Expenditure

The law of diminishing marginal utility is used to determine the amount of money to be spent on a particular commodity. Usually, people do not tend to pay a higher price than the optimum value for a commodity. The value comes to people naturally.

In this case, people use the law of diminishing marginal utility to determine the optimum utilization of their wealth.

Limitations of the Law of Diminishing Marginal Utility

There are some limitations of the law of diminishing marginal utility. They are as stated below:

Unrealistic Assumptions: The law of diminishing marginal utility is based upon the unrealistic assumptions that are hard to get at once.

Inapplicability: The law is inapplicable to some goods, such as TVs, fridges, and ACs as their consumption is not continuous.

Constant Marginal Utility of Money: The law assumed that the marginal utility of money is constant which is unrealistic.

Change in other people’s stock: The law implies that the utility is dependent on what other people have in stock. So, it is based on social needs.

Other possessions: The law is unrealistic in the cases where it depends on other possessions of the consumer.

Conclusion

The law of diminishing marginal utility is applicable to most cases of consumer choice and pricing. It is also used in various other fields, such as psychology, human behavior, and marketing. As a precursor of demand, the law helps businesses determine their product attributes too. It is a very important topic of study in economics.

FAQs

Qns 1. Why is continuity in consumption important for the law of diminishing marginal utility?

Ans. Continuity is important because a gap can change the status of satisfaction. For example, in case someone is consuming ice cream, if a long break is taken, the satisfaction levels may be the same for two successive consumptions.

Qns 2. Can the value of marginal utility be negative?

Ans. Yes. As the value of utility goes on decreasing, it may attain a zero or negative value.

Qns 3. Give an example where the law of diminishing utility is violated.

Ans. The law of diminishing marginal utility is violated in the case of hobbies; such as stamp collection where the utility does not decrease with a successive collection.

raja
Updated on 13-Oct-2022 11:19:47

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