Economic: Microeconomic | Theory of Consumer Behaviour |Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility was first developed by a German Economist Herman Heinrich Gossen, in 1854. This law is known as The First Law of Gossen and later on, it was popularized by Alfred Marshall.

Law of diminishing marginal utility can be defined as the consumer consuming more & more unit of same commodity where utility obtained from that commodity decrease but total utility of the consumer increase in decreasing rate.

In 1854, H. Gossoon explained this law after Alfred Marshall in the following words, “ Other things remaining same, marginal utility becomes smaller and smaller as the more units of a commodity a person has."

According to Alfred Marshall, ' The Law of Diminishing Marginal Utility is defined as the additional utility which a person derives from an increase of his stock of a commodity diminishes with every increase in the stock that he or she already has."

This law says that the additional level of satisfaction goes on diminishing with every increase in units of consumption within the same period of time. When a consumer consumes more and more units of the same commodity, the successive level of utility diminishes.

ASSUMPTIONS

The Law of Diminishing Marginal Utility is based upon the following assumptions:

1. The consumer should be rational:

The consumer is regarded as the rational person who aims to maximize their satisfaction with their perfect knowledge required to maximize the satisfaction of the constraints imposed by their income and commodities.

2. Cardinal measurement of utility:

The consumption utility of any commodity can be measured. It is assumed that the satisfaction can be measured in the same way that the natural units of consumption can be calculated.

3. Constant Marginal utility of money:

This theory assumes utility can be measured in terms of cordial number. The basis of measurement of utility is money. Money is the measuring rod of utility. Being a measuring rod of utility, the marginal utility of money remains constant over the period of consumption.

4. Homogeneous units of goods:

The units of goods consumed by the consumer must be identical size. i.e homogeneous and same quality. otherwise, the law will not apply.

5. No change in task and preferences of the consumer:

It is required that the preference of the consumer do not change. Only then we can assume that the marginal utility declines as consumption increase.

The Law of Diminishing Marginal Utility can be explained by means of a numerical table and geometrically with a diagram which is given below:

 

Units of good 'X'	Total Utility	Marginal Utility
0	0	10
1	10	8
2	18	6
3	24	4
4	28	2
5	30	0
6	30	-2
7	20	-4

 

The given table shows that a consumed goes on consuming goods the additional utility or marginal utility that the consumer obtained by consuming each successive unit of goods of 'x' goes on decreasing till it goes down to zero at the sixth unit and it becomes negative with the 7^th unit. The total utility goes on increasing until the consumption of 5^th unit and in the 6^th unit the total utility stays constant but decreases in the 7^th unit. The total utility increases at a diminishing rate. It is due to the diminishing marginal utility that the total utility increases at a decreasing rate.

In the figure, MU_x is the marginal utility curve, which is derived on the basis of an individual consumption of successive units of good 'X'. MU_x is downward sloping curve which means successive goods 'X' goes on declining throughout below the X-axis which indicates negative utility.

When the marginal utility is positive the total utility increases at a decreasing rate by upward sloping portion of the total utility curve TU_x. Total utility is maximum where the marginal utility is zero. At the 6^th unit, marginal utility becomes zero with the state of maximum satisfaction and total utility of 6^th unit is 30. When marginal utility becomes negative, the total utility curve starts to fall by the downward sloping portion of TU_xcurve.

 

LIMITATIONS OF THE LAW

The Law of Diminishing Marginal Utility is based on certain assumptions. In most of the time, these assumption are applicable. The law is not applicable in the case of the following situations:

1. Irrational Consumers:
     This law assumes that a consumer is a rational person. But, in reality, most of the people are irrational because they use their income without thinking.
   
   
2. Cardinal Utility cannot be measured in number:
     This law is based on upon cardinal utility approach, in which differs from person to person & it is not possible to measure it in exact numbers.
   
   
3. Indivisible commodity:
     This theory is applied only for divisible goods. But in real life, there are so many indivisible goods if divided into small units they loos utility.
   
   
4. Doesn't apply to the basic goods:
     The law of diminishing marginal utility fails even to basic goods such as food, clothes, air, etc. don't diminish from their additional unit of consumption.
   
   
5. Does not apply to the goods of entertainment:
     This law doesn't apply to the goods of entertainment like CD, TU, DVD, etc because the use of such goods provides more satisfaction to the consumers.

IMPORTANCE OF LAW OF DIMINISHING MARGINAL UTILITY

• MGuidelines for taxation

It guides the finance minister while formulating the tax policy. A progressive tax policy, high tax for high-income people and low tax for low-income people, is based upon the marginal utility theory.

• Basic for price determination

When a marginal utility is at least equal to its price,consumer desire to purchase the goods. The consumer will pay a higher price for those having higher MU and vice-versa.

• Guidelines for the distribution of national wealth

The distribution of wealth and national income should be done as per the guidelines of MU theory. Since, the demand of rich people beyond certain has a diminishing utility whereas if the government distribute the wealth to poor, it has definitely a higher marginal utility.

• Basis for various laws in economics

Various laws in economics are based on a law of diminishing marginal utility. For example, law of demand, a law of substitution etc. These laws are derived from the law of diminishing marginal utility.

• Basis for consumer expenditure:

This law is important to regulate the expenditure of the consumers. The consumer has a limited amount of budget with them. So, they do not waste budget by purchasing more qualities. They stop their further purchase at a point where MU equal to price.