Beginners’ Guide to the Law of Diminishing Marginal Utility

The below mentioned article provides a beginners’ guide to the law of diminishing marginal utility.

This article will you to understand the following things: 1. Introduction to Law of Diminishing Marginal Utility 2. Definitions of the Law of Diminishing Marginal Utility 3. Assumptions 4. Explanation 5. Diagrammatic Representation 6. Causes 7. Exceptions 8. Importance 9. Criticisms.

Introduction to Law of Diminishing Marginal Utility:

Law of Diminishing Marginal Utility was first of all introduced by a German Scientist H. H. Gossen in the year 1854.

Therefore, this law is also called as First Law of Gossen. The Second Law of Gossen is Law of Equimarginal Utility.

According to him—”The amount of one and the same satisfaction declines as we proceed with that satisfaction until satiety is reached.”

The Law of Diminishing Marginal Utility (DMU) lies at the centre of the cardinalist approach. The law of Diminishing Utility or Diminishing Marginal Utility is based on the satiability characteristics of human wants, that a single want taken separately at a time can be fully satisfied. In this connection Prof. Clark has said — “It is one of those universal principles which govern the economic life in all the Stages of Development.”

Definitions of the Law of Diminishing Marginal Utility:

Important definitions of Diminishing Marginal Utility are as follows:

1. According to Professor Marshall – “The additional benefit which a person derives from a given increase in his stock of anything diminishes, other things being equal with every increase in the stock that he already has.”

2. As Prof. Henderson has said – “The Marginal Utility of any one commodity diminishes with every increase the amount that he has.”

3. According to Chapman – “The more we have of a thing the less we want additional increment of it or the more we want not to have additional increment of it.”

4. As Briggs has said – “The Marginal Utility of similar goods decreases with increase in the number of units of it in stock.”

5. According to Boulding – “As a consumer increases the consumption of any one commodity keeping constant the consumption of all other commodities, the marginal utility of the variable commodity must eventually decline.”

From the definitions written above we can state that the Law of Diminishing Marginal Utility simply states that other things being equal, the marginal utility derived from successive units of a given commodity declines or diminishes. The law of Diminishing Marginal Utility explains our general experience when we consume or acquire successive units of a commodity.

The additional utility we derive from every extra unit of the commodity goes on declining as we consume (or acquire) more of it.

Assumptions or Limitations of the Law of Diminishing Marginal Utility:

The law of Diminishing Marginal Utility states that, other things being equal, Marginal Utility of a commodity diminishes with the increase in its stocks acquired or consumed. The phrase “other things being equal” implies that the law is conditional.

It will hold true only if certain things remain unchanged during the operation of the law. These “other things being equal” are called “Ceferis paribus” i.e., assumptions or conditions of this law. The validity of this law depends on the following conditions or assumptions.

1. The Process of Consumption should be Continuous:

The process of consumption should be continuous. There should not be time gap in consumption for application of the law. It means that the units of consumption are taken successively one after another and that there is no unduly long-time gap between successive, units consumed. If one bread is taken in the morning and another in the evening, its Marginal Utility does not diminish.

2. No Changes in the Mental Condition of the Consumer:

All the units of the commodity for consumption must be of uniform quality and quantity. It means all the units of the commodity consumed or acquired should be homogeneous i.e., identical in all respects. There should be no difference in the various units of the commodity in respect of size, taste, colour and such other characteristics. All the units are alike in all respects. The law will not hold true, if all the units consumed are not homogeneous.

For Example:

If the first apple is sour and the next one is sweet, the law will not hold good. Utility of the second apple will be higher that of the first one. There will be increasing rather than decreasing marginal utility.

3. Units of the Commodity should be of Normal Standard Units:

It is assumed that the units of consumption of the commodity should be of normal standard size. This means that the units are neither too small not too big.

For Example:

We consider the utility of each apple rather than a dozen of them taken together and consider the utility from the first apple, then from the second apple and so on. Similarly, we consider the utility of a cup of tea and not of tea taken by spoonful’s.

4. There should be no Change in the Taste, Fashion and Habit of the Consumer:

There should be no change in the habit, taste or preference of the consumer throughout the course of consumption. If there is a change, the law will not operate.

For example:

If a vegetarian consumes an egg, initially, he may not find utility in it because of his dislike for it but once he develops a taste for it, another egg gives him more utility or satisfaction.

5. Behaviour of the Consumer should be Normal and Rational:

It should be assumed that the behaviour of the consumer is normal and rational. He knows perfectly the utility he derives from the successive units of the commodity consumed and he is seeking maximum satisfaction.

6. The Price of the Commodity and its Substitute should Remain the Same:

The utility of the goods is related with the price. If the price of the goods falls down then demand and utility both increases. Similarly, there should be no change in the price of the substituted goods.

For example:

Coffee is substitute of tea, if the price of coffee increases and the price of tea remains the same, it is but natural that the demand for tea will increase. Thus, in the increase of price, this law will not operate.

7. There should be no Variation in the Price of the Goods:

Price of the goods must be static and there should not be vast variation. If the price of the goods will be cheaper the demand for the goods will increase.

Explanation of the Law of Diminishing Marginal Utility:

The Law of Diminishing Marginal Utility is an important law in consumption which relates to the fact that as we go on consuming a commodity the satisfaction derived from its successive units goes on decreasing. In other words, it can be said that more we have of a commodity, the less we want to have more of it. At each step its utility (Marginal Utility, not Total Utility) goes on decreasing. Therefore, the law states that other things being equal, as the quantity of commodity consumed or acquired by the consumer increases the marginal utility to that commodity tends to diminish.

According to Prof. Marshall—”The additional benefit which a person derives from a given increase in his stock of a thing, diminishes with every increase in the stock that he already has.”

In other-words, the Law of Diminishing Marginal Utility simply states that, other things being equal the Marginal Utility derived from successive unties of a given commodity declines, or diminishes.

The Law of Diminishing Marginal Utility explains our general experience when we consume or acquire successive units of a commodity. The additional utility we derive from every extra unit of the commodity goes on declining as we consume (or acquire) more of it.

The law may be explained and illustrated with the help of the following utility scheduled:

It can be seen from the table given above that when the consumer consumes the first apple, Marginal Utility is 10, but the second apple gives units of Marginal Utility and so on. In this way Marginal Utility diminishes, as he goes on consuming more and more apples. A point is reached when an additional unit consumed will not yield any utility.

Eventually, the Marginal Utility implies the point of satiety that is; there is complete satisfaction of a given want when marginal utility is zero. The Marginal Utility becomes zero only when the wants intensity is nil, as it is fully satisfied. It must however, be remembered that though Marginal Utility varies inversely with the acquisition or consumption of the stock of a given commodity, the variation is not necessarily proportionate or uniform.

And if any such thing is observed, it is incidental. Any further addition to consumption after zero marginal. Utility causes a negative Marginal Utility. Negative Marginal Utility indicates dis-utility or dis-satisfaction resulting from excessive consumption of a commodity.

Further, viewing the schedule in its ascending order, it would be seen that with a decrease in the stock of consumption, the Marginal Utility increases. Hence, when one wants to increase, the marginal utility of a commodity, he should consume or purchase less of it.

Diagrammatic Representation:

This can be understood better with the help of the following diagram:

OX and OY are the two axes. A long OX are represented the units of the commodity. ‘Apples’ and a long OY is measured the Marginal Utility corresponding to the consumption of each unit. AB is the utility curve. PD is the utility when one apple is taken. QE is the additional utility when two apples are taken. QE is less than PD. The additional utilities of other successive units are RF. It can be seen that at each step, the additional utility becomes smaller and smaller.

At the S point there is no addition at all i.e., the Marginal Utility is zero and then it becomes negative which is represented here below the axis of X. To understand clearly we should study initial utility, total utility, zero utility and negative utility.

Initial Utility:

It is the utility of the initial or the first unit of the commodity which we consume.

Total Utility:

Look at the column 3 of the above Utility Schedule Table. It gives the total utility at each step. For example—If we consume one apple the total utility is 10; if we consume two, the Total Utility is 18 and so on.

Zero Utility:

When the consumption of a unit of a commodity makes no addition to the Total Utility, then it is the point of Zero Utility. In the table given above the Total Utility is after the 3 unit is consumed is 22. At the fourth also it is 22. Thus, the 4 apple results in no increase whatsoever. This is the point of Zero Utility. Therefore, it can be observed that the Total Utility is maximum when the Marginal Utility is zero.

Negative Utility:

If the consumption of a commodity is carried to excess; then instead of giving any satisfaction it may cause dis-satisfaction. The utility in such cases will be negative. In the table given above the Marginal Utility of the 5th and 6th units is negative.

Causes of the Law of Diminishing Marginal Utility?

Prof Boulding has given two reasons for the decline of Marginal Utility:

1. Each Particular want is Satiable:

Although wants are unlimited, still particular want is satiable because our capacity to consume that article is limited. We cannot use any commodity in unlimited units. After using the units we reach a successive units where our satisfaction is complete and that point is point of zero. Up to zero our utility is positive and using beyond zero it becomes negative.

2. All Commodities are not Complete Substitute of Each Other:

We cannot use all commodities as complete substitute of another commodity. Commodity adds utility only when it is used in ideal proportion. For example—A trouser can’t be a complete substitute of full shirt. Non-substitution of the commodity reduces Marginal Utility of that commodity.

Exceptions to the Law of Diminishing Marginal Utility:

Under the above stated conditions of continuity, consistency rationality, homogeneity and reasonability, the law is deemed to be universal. In certain cases it has been observed that a consumer tends to attain increasing Marginal Utility when an increase in the stock of a commodity consumed or acquired.

Such cases are treated as exceptions to the Law of Diminishing Marginal Utility. But strictly speaking these so called exceptions are not very genuine cases and are found to be erroneous when we strictly apply the criteria of the law all the ‘Ceteris Paribus,” assumptions.

Let up consider the exceptions one by one:

1. The Law is not Applicable to Good Poetry and Good Song:

In the case of good poetry and good music, it has been experienced that a repeat hearing gives a better satisfaction than the first one. Hence, the Law of Diminishing Marginal Utility may not be applicable here. But, we can say that there is a limit to it, as several repeated hearings of the same music or poetry proves to be monotonous and ultimately yields dis-unity, who does not know the effect of “too much of a good performance”? So it can be said that it is not a genuine exception to the law.

2. To a Wine Taker (drunkard) the Utility of Additional Cup of Wine Increases:

It is the view of the people that this law seems to be inapplicable to a drunkard as the intoxication increases with every successive dose of liquor. This is true but the rationality condition of the law is violated. The behaviour of a drunkard in a drunken state is irrational or abnormal.

3. The Law is not Applicable if the Units of Commodity are too Small:

In the case of very small units the Marginal Utility will increase instead of decreasing; but ultimately the Marginal Utility will definitely fall if the consumption is continued. For example—If a person is given spoonful of water when he is very thirsty, each successive spoonful will give more satisfaction. But if the unit is the usual tumbler of water, the law starts working at once.

4. Lust for Money and Desire for Display never Reaches the Point of Satiety:

It has been assumed that the Marginal Utility of money does not diminish as one never gets satisfied even though one gets more and more of it.

But this is not a real exception because of the following reasons:

(i) Money does not satisfy a want directly,

(ii) Money implies only purchasing power. Goods purchased with money have diminishing utility,

(iii) Marginal Utility of money itself diminishes though very gradually and slowly.

Though it never becomes zero, but it diminishes. This can be seen from this fact that the utility of a hundred rupee note to a millionaire is far less than its utility to the person who draws a salary of rupees one thousand per month.

5. Collection of Rare and Curious Commodities:

It is often argued that in certain hobbies like stamp collection, collection of antiques, collection of old coins etc., every additional unit gives more pleasure, i.e., the Marginal Utility tends to increase. This is not doubt a true statement, but it is not a genuine exception to the Law of Diminishing Utility because in such cases, the homogeneity condition of the law is violated. Indeed, each time a new variety of stamp or coin or antique is collected by a person but not of the same variety.

6. Greed Increases with Every Additional Acquisition of Money:

In the case of a miser, it has been pointed out that greed increases with every additional acquisition of money. Hence, the Marginal Utility of money does not diminish for him with more and more money. But here we may say that when the miser spends his money, his utility of the commodity will be diminishing perhaps more rapidly than in the case of others. Hence, a miser’s behaviour cannot be a significant exception to the diminishing Marginal Utility.

7. Presence of Supplementary Goods:

If the supplementary goods are available, this rule will not apply because, the utility of supplementary goods increases. For example: The utility of lantern increases by the proper supply of kerosene oil. But this has not been accepted as correct exception because the law operates in only one goods.

8. Student’s Reading Books:

Since more reading gives more knowledge, a scholar would get more and more satisfaction from every additional book. But here it can be said that it is not a real exception to the law as the homogeneity condition is violated. Knowledge and satisfaction increases by reading different books and not the same one, over and over again.

In the end it can be said that “the Law of Diminishing Marginal Utility is true with no real exception”. In this connection Prof. Taussig has said—”the tendency of diminishing Marginal Utility operates so widely and with so few exceptions that there is no significant inaccuracy in speaking of it as universal.”

Prof. Clark is of this opinion that “Law of Diminishing Marginal Utility is one of those universal principles which govern the economic life in all stages of development.” From the above analysis conclusion may be drawn that the exceptions to the Law of Diminishing Marginal Utility are only apparent and not real. Hence, it can be said that the law is universally applicable.

Importance of the Law of Diminishing Marginal Utility:

The Law of Diminishing Marginal Utility has great economic importance.

Its importance has been divided under two heads:

1. Theoretical Importance, and

2. Practical Importance.

Theoretical Importance:

From theoretical point of view, its importance is as follows:

1. It is helpful in the study of consumer’s behavior:

The law explains the behaviour and equilibrium condition of a rational consumer with respect to a single want and commodity. Prof. Marshall has said that—”to get maximum satisfaction consumer takes the help of law of Equimarginal Utility and this law is based on Diminishing Marginal Utility.”

2. It is the basic law of consumption:

The Law of Diminishing Marginal Utility is the basic law of consumption. The law of demand, the Law of Equimarginal Utility and the concept of consumer’s surplus are based on it.

3. Basis of value theory and price determination:

The law helps to explain the phenomenon in value theory that the price of a commodity falls when its supply increases. It is because with the increase in the stock of a commodity its Marginal Utility diminishes.

4. Basis of law of demand:

The Law of Diminishing Marginal Utility serves as the basis of the law of demand. It explains the reasoning behind the inverse functional relationship between price and demand.

5. Smith’s “diamond-water paradox” can be explained with the help of the law:

The law explains the difference between value-in-use and value in exchange of a commodity. Thus, it explains the paradox of values. In fact the paradox of value-in-exchange and value in use in respect of commodities like water and diamonds can be explained in terms of the difference between Marginal and Total Utility.

For example:

Though, the Total Utility of water is quite high as also its value in use, its value in exchange is very low and insignificant, because its Marginal Utility is very low and diminishes very rapidly. On the other hand, even though the Total Utility of diamonds may not be as high as that of water its price or value-in-exchange may be very high, just because its marginal utility is very high and it diminishes very slowly.

In this way Marginal Utility influences, the value-in-exchange to a great extent, apart from the scarcity factor of commodity. Marginal Utility indicates the degree of intensity of want. Total Utility denotes only the extent of the satisfaction. Maximum Total Utility implies maximum satisfaction. But a higher Marginal Utility of a commodity implies that people want it very intensely and therefore are ready to pay a higher price.

6. This law helps in bringing variety in consumption and production:

Here the change in design, pattern and packing of commodities very often brought about by producers are in keeping with this law. We are aware that the use of the same goods makes us feel bored; its utility diminishes in our estimates. We want variety in soaps, tooth pastes, pens etc.

Practical Importance:

The law has the following practical importance:

1. Importance in the field of production:

The law serves as a guide to producers to promote sales by reducing price. Because when the price falls, to attain equilibrium the consumer has to decrease the Marginal Utility to that extent. To do this, he has to purchase more goods as the Marginal Utility diminishes only when the stock is increased.

2. Useful in public finance:

The law serves as a very useful instrument to Finance Minister in formulating an appropriate taxation policy. He can justify progressive taxation of higher incomes on the ground that the rich people will feel a relatively less impact of tax burden as their Marginal Utility of money is lower with the increase in income.

3. Socialist plea for an equitable distribution of wealth:

This law underlines the socialist plea for an equitable distribution of wealth. The Marginal Utility of money to the rich people is lower. It is, therefore, advisable that their surplus wealth be acquired by the state and distributed to the poor who possess high utility for money.

Criticisms of the Law of Diminishing Marginal Utility:

Though the law expresses a universal tendency of consumer’s intro-specific behaviour its traditional exposition has been criticised on various grounds:

1. Consumers are Ignorant about Other Useful Alternatives:

In this law it has been assumed that the consumer has a perfect knowledge of the alternative choices open to him. But in reality, most of the consumers are ignorant about their useful alternatives on which they could spend their income. This makes the act of substitution difficult and the law inoperative.

2. Utility not Measurable:

The Marshallian explanation of the law presumes the cardinal measurement of utility. The utility schedule used for this assumes that utility can be numerically measured, added or subtracted. This is not convincing because utility being a subjective or psychological phenomenon, cannot be measured numerically. It is a feeling experienced by the consumer. A feeling being subjective cannot be quantified.

Some economists are of this view that though utility cannot be measured numerically or cardinally, it can be measured in the order of utility as to higher or lower utility which can be determined. Hence, the presumption that additional unit of commodity will give a lower and lower level of satisfaction in perfectly true. Therefore, the law of course is perfect but its cardinal utility measurement is out of question.

3. Law is based on Unrealistic Conditions:

The law is based on unrealistic assump­tions or conditions. It is very difficult to meet the continuity, consistency, homogeneity and rationality conditions simultaneously.

4. The law is Inapplicable in Case of Indivisible Goods:

The application of this law to the assumption of an indivisible bulky commodity sums to be absurd, because no one would normally purchase at a time more than one unit of goods like T.V. set, refrigerator, scooter etc. It would then be absurd to talk of increase in the stock of such type of goods and the Marginal Utility derived from it.

5. Marginal Utility of Money cannot be Constant:

The assumption that the Marginal Utility of money will be constant is quite unrealistic. Critics are of this opinion that the Marginal Utility of money can never remains constant, so it may affect the consumer’s preferences.

To conclude it can be said that despite the drawbacks written above, the law has some validity. Though utility cannot be measured cardinally, it can be compared and measured ordinarily. Therefore, the law cannot be rejected or discarded outright.