Law of Diminishing Marginal Utility: Concept, Assumption, Causes and Issues

Let us make an in-depth study of the concept, assumptions, causes, limitations and issues of the law of diminishing marginal utility.

Concept:

A number of earlier writers like Bentham, Gossen and Marshall stated clearly the concept of diminishing marginal utility.

Liebhafsky stated the principle in the following way:

The satisfaction acquired from addi­tions to one’s stock of a good diminishes.

In the words of Marshall:

“The additional benefit which a person derives from a given increase of his stock of a thing diminishes with the every increase in the stock that he already has.” It means that more one has of anything; less important to him is any one unit of it.

The Law of Diminishing Marginal Utility, as defined above, is derived from one of the characteristics of human wants. It is observed that although a person cannot satisfy all of his wants, he can satisfy one of these provided he has the means to do it. As he gets more and more of a thing (say, an apple or tea), his intensity of desire for that thing gradually diminishes, indicating that additional utility decreases as its total stock increases.

As the consumption of a commodity increases the consumer’s TU also increases. He gets greater satisfaction as he eats more and more chocolates.

But as the consumption of chocolates increases his desire or inclination for every extra unit will gradually fall. In other words, his psychological capacity to appreciate every extra unit will gradually diminish. So every extra unit will add less and less to his total satisfaction. In other words, the rate of increase in TU will fall. In our example the second chocolate gives less satisfaction than the first one.

And a sixth one begins to make the consumer feel ill—total satisfaction from the assumption consumption of chocolate falls. From this emerges one famous law of economics, known as the Law of Diminishing Marginal Utility.

This law can be stated thus:

“The more one consumes of one commodity during any period of time the less satisfaction one gets from consuming an additional unit of it”.

As one adds to his (her) weekly consumption of chocolate, each additional unit adds to his TU or total satisfaction, but each unit adds less utility than the one before it.

Utility schedule presented in Table 4.1 can be represented diagrammatically. See Fig. 4.1. In Fig. 4.1 our representative consumer Mr. John is seen to add to his total satisfaction as he increases weekly purchase of chocolate until he is buying 5 units (bars) per day. A 6th bar per week gives him disutility or dissatis­faction.

Fig. 4.2 (which is derived from Fig. 4.1) illustrates the Law of Diminishing MU. This indicates that the additions to TU of chocolate became less as more bars per day are purchased. It is clear that the MU of the six bars per day is negative, i.e., the sixth bar causes a decrease in TU.

Assumptions of the Law:

The Law of Diminishing Marginal Utility is based on the assumptions:

1. The utility that a consumer gets can be measured and expressed in numbers (utils). Moreover, the units of the commodity must be properly defined.

2. The maximum price a consumer is ready to pay for the commodity depends on its marginal utility to him.

3. The taste and preference of the consumer remain unchanged during the period of purchases.

4. The initial amount of consumption is sufficient to give the consumer full satis­faction.

Causes of Diminishing Marginal Utility:

Three important causes of the diminishing marginal utility are:

1. Satisfaction of a Particular Want:

Although human wants are unlimited, a particular want is limited. So it can be satisfied. As a person consumes more and more of a commodity, his indication becomes less and less. So his marginal utility from the successive units becomes gradually smaller. It means that too many units of a commodity bring complete satisfaction.

2. Introspection:

The validity of the law can be established through introspection (i.e., an examination of one’s own thought or mental reaction). The classical economists used to look into their minds for their own psychological reaction to the extra consumption of a particular thing (say, an apple, an ice-cream, a chocolate, etc.) and tested the truth of the law.

3. Less Important Uses of Additional Quantities:

Furthermore, marginal utility diminishes because a person, having several units of a commodity capable of alternative uses, puts one unit to its most important use and the additional units to the successively less important uses.

Limitations of the Law:

The Law may not operate in certain circumstances and in those exceptional cases the marginal utility of a thing may increase for some time.

Six important exceptional cases to the law are:

1. Change of Taste and Preferences:

If a consumer’s taste changes so that he likes a commodity more, the marginal utility of any quantity of that commodity rises. A person may not have initially any interest in eating egg roll. But after taking one egg roll, he may form a good taste for it and may get a great satisfaction from the 2nd or the 3rd one.

2. Inadequate Initial Consumption:

If a person consumes a very small quantity of a particular thing at the initial stage, he may not get full satisfaction from it. In such a case his satisfaction will be greater from the second unit. Thus, coke in a small glass may not quench one’s thirst at all, as such, the satisfaction from the second one is likely to be greater.

3. Emotional or Fancy Buying:

The marginal utility of a thing does not diminish when a buyer purchases it in a larger quantity out of sheer emotion or fancy. An example is the art work of a known painter or a rare book of a dead author.

4. Miser’s Collections or Hobby Collections:

A miser gets a greater satisfaction from the additional collection of money. Similarly, a person gets more and more satisfaction as his hobby-collections (e.g., stamps, coins, works of art, etc.) increase gradually.

5. Consumption at Different Time Periods:

If a person consumes different units of a particular thing at different times, the marginal utility from the successive units is not likely to be smaller. Thus, if he consumes the 1st ice-cream in the morning, the 2nd in the afternoon and the 3rd at night, the marginal utility may not diminish.

6. Stock with Other Persons:

Sometimes the utility of a thing depends on its stock with the others. If in a locality all but one have two cars, the second car to that man will not yield diminishing utility.

Issues:

Three important issues may now be con­sidered:

1. Can Marginal Utility Ever Become Zero?

In case of most commodities (except money and certain rare goods) consumption beyond a certain point gives no extra utility or satisfaction.

When we are asked if we would like more of a commodity and say ‘yes’, we know that there is a limit to our desire for it (at its present price in any given period). At some fixed point of time (say, a hour, or a day, or a week) we will want less of it than before and after sometime we would not want any more of it at all.

Economists often consider imaginary people in imaginary situations to illustrate this point. One classic example is of the person in the desert who has been deprived of water and who, when offered a glass of water, knows how great its utility is. The second glass also gives him much satisfaction and so does the third, but surely there will come a point when his thirst, even in a desert, will be sated. If he is forced to consume more water his satisfaction will fall.

This is why an individual would not voluntarily continue to consume water, or any other commodity such as food, cigarettes, liquor and recreation when MU becomes negative. In other words, a rational consumer would never so increase his consumption of a commodity as to cause its total utility to be maximum and marginal utility to be zero.

2. Universality of the Law of Diminishing Marginal Utility:

This Law is widely applicable. However, it is wrong to assume that the Law applies to every commodity for every-thing in the real world. There are various exceptions. For example, for those people who drink alcohol due to addiction, the seconds or third drink may give more satisfaction than the first one. But, sooner or later, the point of diminishing MU will be reached because every extra unit will give less and less satisfaction. In fact, if an individual drinks too much he is bound to fall sick.

3. Multiple Use of Goods:

Some commodities are used for specific purposes, such as cooking gas. Others have multiple uses, such as milk. The demand for the latter is called composite demand. In fact, the Law of DMU is related to the number of uses to which a commodity can be put.

This no doubt varies from one commodity to another. For example, let us consider milk. It is consumed by the babies in almost every family. It is used to feed the dogs in some families. It is also used by sweet shops to prepare sweetmeats and by restaurants to make tea.

All these uses of milk have the same value to the person buying it. But some uses have more value than others. R. G. Lipsey has pointed out that the diminishing values of uses helps to explain why the demand for a commodity like milk (and virtually all other commodity) slopes downward. When the price of milk is Rs. 15 per kg it will be purchased mainly for feeding the children.

When the price is a little lower, it may be used to make some sweets for obliging the other members of the family or by offering sweets to neighbours and relatives on a special occasion such as Diwali. When price falls further a cup of tea may be made entirely with milk. However, shop-owners will make more sweets with milk and less with other ingre­dients.

A certain portion may be ‘wasted’ by pouring it on the statue of the Great God— Shiva. The basic point is clear: the large number and variety of uses to which milk can be put in-forces the tendency for MU to fall with an increase in the consumption of a commodity. The reason is simple: as the price of milk falls, it may be used for less valued purposes. At the same time it will be used in large quantities for more valued purposes.

Let us take the example of water to give a clear idea. A minimum quantity of water is essential to maintain our existence. So we are ready to give our entire income to obtain that quantity. So the marginal utility of the minimum quantity is very high. One can drink much more than this quantity. But the MU of more and more glasses of water drunk during a specific time period will gradually fall. So the demand curve for water — like that of any other commodity — is downward sloping from left to right.

However, in a broad sense, water has multiple uses. It is used for various purposes other than drinking — such as to take baths, for washing clothes and cars, watering the flower garden and the lawn, brushing one’s teeth and so on. To any of us, the importance of all these uses will vary. But at any fixed point of time some of the uses are more important than others. So it is quite reasonable to expect that as the price of water-falls it is put to more and more ‘lower utility uses’.

So two major points that emerge from our discussion so far are:

(a) The demand curve for a commodity slopes downward because successive units consumed of it in any one use give less and less satisfaction (i.e., have diminishing MU)

(b) The demand curve is downward sloping for another reason—most commodities have multiple uses that confer different utilities.