Law of diminishing marginal utility

Utility is the satisfaction one gets by consuming a good or a service. Marginal utility is the additional satisfaction one gets by consuming one extra unit of a good or service.

The law of diminishing marginal utility is a law of economics stating that as a person increases consumption of a good or service, while keeping consumption of other things constant, there is a decline in the marginal utility that person derives from consuming each additional unit of that good or service.

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

The law of diminishing utility explains the downward sloping demand curve. The utility of additional units of goods increases as price falls, until price equals the marginal utility. This is the basis which demand curve is derived from.

As more and more quantity of a commodity is consumed, the intensity of desire decreases and also the utility derived from the additional unit.

Suppose a person eats Apples. the first apple gives him maximum satisfaction. When he eats the 2nd apple his total satisfaction would increase. But the utility added by the 2nd apple (the marginal utility) is less then the 1st apple. His Total utility and marginal utility can be put in the form of a following schedule.

Number of Apples eaten Total Utility Marginal Utility
1 50 50
2 75 25
3 87 12
4 93 6
5 96 3
6 93 -3

When he eats the 6th apple, his marginal utility is negative, which means it gives him a dis-utility.

total-and-marginal-utility-curve

diminishing marginal return

The law of diminishing utility explains the downward sloping demand curve. The utility of additional units of goods increases as price falls, until price equals the marginal utility. This is the basis which demand curve is derived from.

Equi-marginal principle

As we know, economics is the study of how we take our actions to satisfy our wants in the best way possible. Individuals are always concerned about maximizing their satisfaction. With the availability of certain amount of resources (money for example), a person chooses to buy a combination of different goods that will give him the maximum total utility. It is also the case that the marginal utility enjoyed from each unit of goods or services in that combination is equal at their optimum level. This is known as the equi-marginal principle.

This can be expressed by using the formula:

Marginal Utility of A


Price of A

= Marginal Utility of B


Price of B

Or using the formula:
MU1/MC1 = MU2/ MC2 = ………. = MUn/ MCn
Where MU1 = marginal utility from good one and MC1 is the marginal cost (price) of that good;
MU2 = marginal utility from good one and MC2 is the marginal cost (price) of that good.
The Equimarginal Principle
Number
Marginal Utility of T-Shirts
Marginal Utility of Pizzas
First
11
8
Second
9
7
Third
7
6
Fourth
4
5
Fifth
1
4

When we look at this information, we can see that the marginal utility of both the goods equal at the 2nd T-Shirt and Third Pizza. Therefore, the particular person will buy 3 pizzas and 2 shirts.

Assumptions of Equi-marginal Principle

  • Utility could be calculated in cardinal numbers.
  • Consumer is rational. He desires maximum satisfaction from income.
  • The income of purchaser is steady.
  • The prices of products stay constant.
  • A good can be split up in small portion. It means that the purchaser can spend his income as he wishes.
  • The customer has understanding of the utility offered by different products.
  • Utility which a person receives from a product is determined by the quantity of that product only. It’s not at all influenced by the utility resulting from other items.
  • Consumption is made at a certain period of time. This implies that the budget period of the purchaser is constant.

Limitations of marginal utility theory

  • Difficulty of evaluating utility. Consumers often are not able to determine exactly how much utility will the consumption of a particular good will give. Especially if it is a new item, they won’t know it until after they have enjoyed the new product.
  • Consumers don’t have time to work out Marginal utility / price. Instead, they often purchase out of habit or gut feeling.
  • Consumers are not always rational. For example, we often see over-consumption of demerit goods. These goods actually give very low marginal benefit. Consumers may also be influenced by advertising and they often purchase on impulse.
  • Numerous goods. In the real world, consumers have fluctuating income, and innumerable goods to choose between. This makes even rough calculations difficult.
  • Many goods can’t be split up into small portions, e.g. cars.
  • Many goods are related – the utility of a DVD player, depends on the quality of DVDs and movies that come in those.

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