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Economics Discussion

Utility Analysis of
Demand: Law of
Diminishing Marginal
Utility
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Read this article to learn about the Law

of Diminishing Marginal Utility!

Marginal Utility is the utility at the point

where the consumer stops further
Ad
consumption of a commodity.

Statement and Explanation of the Law:

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A very important law in consumption relates
to the fact that as we go on consuming a
commodity, the satisfaction derived from its
successive units goes on decreasing.

It is well known that familiarity breeds

contempt. The more we have of a commodity,
the less we want to have more of it. It is the
experience of every consumer that as he goes
on consuming a particular commodity, each
successive unit of the commodity yields him
less and less satisfaction.

In other words, at each step its utility

(marginal utility, not total utility) goes on
decreasing.

Thus if we are very thirsty and buy a drink to

quench our thirst, the drink will yield a great
deal of satisfaction at first. After the
consumption of the first drink, however, we
would not like to have another, because our
want has been practically satisfied. This is the
case with most of the commodities.

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Dr. Marshall states the law thus:

“The additional benefit which a person derives

from a given increase of his stock of anything
diminishes with the growth of the stock that he
has.” In this statement of the law, the word
“Additional” is very important. It is only
additional (marginal) benefit which decrease
and not the total benefit as we shall see in the
following table.

The following table relating to an

imaginary consumer consuming
‘rasgullas’ illustrates the law:

As the consumer goes on eating ‘rasgullas’, the

additional or marginal utility goes on
decreasing. The 7th ‘rasgulla’ yields no
additional satisfaction and the 8th and 9th
have a negative utility (see column 2). Their
consumption, instead of giving satisfaction or
pleasure, causes dissatisfaction.

If you look at column 3, you will find that the

total utility goes on increasing up to a point. It
also seems reasonable that the utility of two
‘rasgullas” should be more than that of one,
and the total utility of three more than that of
two, and so on. But if you look at it more
carefully, you will notice that although the
total utility does increase, it increases only at a
diminishing rate.

(1) No. of (3) Total

Rasgullas Marginal Utility
Utility (2)

1 15 15

2 13 28

3 10 38

4 8 46

5 4 50

6 2 52

7 0 52
 8 -2 50

9 -5 45

For example, when our friend consumes the

second ‘rasgulla’, the increase in utility is 13;
and when he-consumes the third, the total
utility increases by 10 only. Column 2 shows
the rate at which utility increases. We can see
that it increases at a diminishing rate In other
words, the marginal utility decreases. (We
shall discuss marginal utility more fully
presently).

Diagrammatic Representation:

This law can be understood better with

the help of the following diagram:

OX and OY are the two axes. Along OX are

represented the units of the commodity,
‘rasgullas’, and along OY is measured the
marginal utility corre​sponding to the
consumption of each unit; UU’ is the utility
curve. AB is the utility when one ‘rasgulla’ is
taken. CD is the additional utility when two of
them are taken: CD is less than AB. The
additional utilities of other successive Units
are EF, GH. KL and MN.

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It can be seen that at each step, the additional
utility becomes smaller and smaller. At the
seventh unit, there is no addition at all, i.e., the
marginal utility is zero, and then it becomes
negative, which is re​presented by the shaded
area below the axis of X.

We may distinguish between initial utility,

total utility, and zero utility and negative
utility.

Initial Utility:

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It is the utility of the initial or the first unit. In

the table given on the previous page, the initial
utility is 15.

Total Utility:

Look at column 3 of the table. It gives the total

utility at earn step. For example, if you
consume one ‘rasgulla’, the total utility is 15; if
you consume two, the total utility is 28, 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 our
table, the total utility, after the 6th unit is
consumed, is 52. At the seventh also it is 52.
Thus, the seventh ‘rasgulla results’ in no
increase whatsoever. This is the point o’ zero
utility, it is thus seen 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 dissatisfaction. The
utility in such cases is negative. In the table
given above the marginal utility of the 8th and
the 9th units is negative.

Limitations or Exceptions:

The Law of Diminishing Utility says that as we

go on consuming more and more units of a
commodity, the utility falls with every
successive unit consumed. But this is not
always true. We may, therefore, see below
what those limitations or exceptions are.

Dissimilar Units:

If the units are not identical, the law will not

apply For instance, if the second ‘rasgulla’ is
much larger than the first-one, it will yield
more satisfaction than the first. The law will
apply only if the units are similar.

Very Small Units:

If we are given water by the Spoonful when we

.are very thirsty, each successive spoonful will
give us more satisfaction. If, however, the unit
is the usual tumbler of water, the law starts
working at once. In the case of very small
units, the law applies at a later stage. At first
the marginal utility will therefore, increase
instead of decreasing. But ultimately the
marginal utility must fall if the consumption is
continued, and this is exactly what the law
says.

Too Long an Interval:

Suppose you take your morning meal at 10

A.M. and your dinner at 8 P.M. If you eat
nothing in between, the dinner will probably
yield even greater satisfaction than your
breakfast. But if you are asked to take another
meal within an hour of the first, the law
undoubtedly applies. The law, therefore,
applies only when the units of the commodity
are taken quickly one after another within a
reasonable period of time.

Rare Collections:

The law does not apply in the case of rare

collections. If a person has a hobby of
collecting rare coins, the larger the number he
collects the greater will be his happiness,
whereas according to this law it should be less
and less.

Abnormal Persons:

When we discuss this law, we assume that we

are talking of normal persons. But there are
some abnormal people too, e.g., misers. The
more money a miser has, the greater is the
satisfaction that he derives. The law, therefore,
does not apply to abnormal persons like
misers, drunkards, musicians, etc., who want
more and more of the commodity they are in
love with. In such cases, the consumption
excites further desire and hence yields greater
satisfaction.

Change in another Person’s Stock:

Sometimes utility changes not because change

has taken place in the stock of the commodity
that a person has of clause a change has taken
peace in another person’s stock. Suppose,
there are two persons collecting stamps in a
town and both are rivals. Suppose further that
by an accident the stock of one of them is
destroyed. Automatically, the value of the
stock of the other person will go up even
though there has been no change in his stock.

Changes in Income, Habits and Tastes:

We may add that a change in a consumer’s

income, a change in fashion, and a change in
other possessions of the consumer also seem
to upset the Law of Diminishing Marginal
Utility. In such cases, increase in consumption
may yield greater and greater satisfaction.

Conclusion:

However, in spite of the above limitations or

exceptions, the law has universal application.
This is so because it expresses a basic principle
of human behaviour.

Does the Law of Diminishing Marginal

Utility Apply to Money?

It is sometimes said that the law of

diminishing marginal utility could not apply to
money. Since money can command an endless
variety of commodities and services, there can
be no end to a craving for money. More money
will be welcomed even if a person has already
much of it.

The more he has of it, the more he would like

to have it. It would enable him to enjoy not
only a large variety of material objects, but
would also bring him prestige, power and
distinction. Therefore, it is urged that the law
of diminishing marginal utility does not apply
to money. But a little thought will show that
even money is no exception to the law. Every
addition to our stock of money, however
welcome it may be, has less significance, i.e.,
we do not attach the same importance to it. As
a man grows rich, he becomes careless in
spending money. He wastes it on useless
luxuries which do him no good.

It only means that a person does not attach the

same importance to additional wealth, or that
its marginal utility decreases. That is why the-
Government taxes the rich people. The richer
they are, the higher the taxes they have to pay.
The basis of the principle of progressive
taxation is the law of diminishing marginal
utility. Hence the law of diminishing marginal
utility undoubtedly applies to money.

Marginal Utility:

We have been talking about marginal utility

without clearly explaining to the student what
it means. We shall now explain it fully. We
may say roughly that Marginal Utility is the
utility at the point where the consumer stops
further consumption of a commodity.

That is why it is also called the find utility. But

where does a consumer stop? If you are invited
by a friend to a feast of ‘rasgullas,’ you will
stop when the satiety level is reached, i.e.,
when you cannot eat any more ‘rasgullas’. In
other words, you will stop at the joint of zero
utility. This is the case, however, when you
have not got to pay anything for the ‘rasgullas’.

One does not, however, receive invitation to a

least every day. A consumer has ordinarily to
pay for what he wants to take. In that case, he
will naturally weigh in his mind the price that
he has to pay and the pleasure that he gets. So
long as the utility is greater than the price, he
will go on consuming. But as he goes on, the
utility steadily decreases. Sooner or later, a
point will be reached when the utility and price
balance each other.
Obviously, he will stop eating at this point, for
if he goes further, the utility will be less than
the price and he will be closer. This is the point
of marginal utility. At this point, the benefit
received is just equal to the price that has been
paid.

Properly speaking, Marginal Utility may be

defined as the addition to the total utility by
the consumption of the last unit considered
just worthwhile.

If our consumer stops after consuming the 5th

“rasgulla,’ the marginal utility is 4. Where he
actually stops will depend on the price of the
commodity. Because if the price falls, he will
consume more and the marginal utility will go
down, and vice versa.

We may here warn the student that it is wrong

to say that the marginal utility in this case is
(he utility of the 5th ‘ragulla.’ All the ‘rasgullas’
arc alike, they cannot have different utilities.
But because a ‘rasgulla’ happens to be taken in
the 5th place, its utility is less than that of each
of those taken previously. Hence, it is best to
say that the marginal utility is what is added to
the previous total when the unit, which is
considered just worthwhile purchasing, is
consumed.

Margin is not fixed:

It moves back and forth. If the price rises, we
shall stop earlier. But if it falls, we shall
purchase more. Thus, the margin is shifted as
the price of the commodity changes.

The relation between price and

marginal utility is discussed below:

Marginal Utility and Price:

Suppose each unit of marginal utility is worth

ten paisa. This would mean that the utility of
the first ‘rasgulla’ is equal to fifteen ten paisa.
Suppose ‘rasgullas’ are being sold at 80 paisa
each. Then we shall stop buying at the 4th
because at this point marginal utility and price
have been equalised. At the third, the utility is
worth Re. 1, whereas the price is 80 paisa.
Hence we are tempted to buy the next, i.e., the
4th, but no more.

At this point, the price is 80 paisa and the

utility is also worth 80 paisa. The two coincide.
If the price of a ‘rasgulla’ were to fall to twenty
paisa each, we shall buy even the 6th, for it is
at that point that the marginal utility and the
price will be equal. This is how the margin will
shift with each change in price and the shifting
will continue until price and marginal
utilityhave been equalized.

That is why it is said that price measures

marginal utility. When we pay a certain price
for a commodity, it can be taken for granted
that we think that the satisfaction is at least
equal to the price paid. Hence we say that
price measures the marginal utility or that
marginal utility indicates the price.

Marginal Utility does not determine Price. The

relation between marginal utility and price
may be carefully understood. They move
together. If the price goes up, the marginal
utility also goes up because now we buy less,
and vice versa. The two coincide. But it is
wrong to say that the marginal utility
determines or governs price. It simply
indicates it Instead of marginal utility
determining price both marginal utility and
price are governed by demand and supply.

Importance of the Law of Diminishing

Marginal Utility:

The law of diminishing marginal utility

expresses a basic principle of a consumer’s
behaviour. And the law is of immense use to a
person in almost every walk of life.

In Taxation:

We have seen that the law is applicable in the

sphere of taxation a man’s income increases;
he is more heavily taxed, for the utility of
money to a rich person is less than that to a
poor person. The principle of progressive
taxation is based on this law.

In Determining Prices:

The law also applies to the determination of

market price increase in the stock of a
commodity brings a person less satisfaction;
therefore he can be induced to buy more only
if the price is lowered. Thus, great the supply,
the lower should be the price to clear it, and
vice versa.

In Support of Socialism:

Socialists, take their stand on this law when

they advocate a more equal distribution of
Wealth. They argue that excessive wealth in
the hands of the rich is not so useful from the
social point of view, as it would be if the excess
of wealth is transferred the poor. In the hands
of the poor, it will satisfy more urgent needs. It
is due to the law of diminishing marginal uti​-
lity that, beyond a certain point, wealth will
have less utility for a rich man. If it is
transferred to the poor, it will have much
greater utility.

In Household Expenditure:

The law of diminishing marginal utility

regulates our daily expenditure. We know that
as we go on buying more of a commodity, its
marginal utility falls. Having only a limited
amount of money at our disposal,’ we cannot
waste it unnecessarily on a large quantity of
any one commodity. We, therefore, stop
purchasing it at a point where the utility of
money spent is equal to the utility of the last
unit of the commodity purchased. We spend
the rest of our money on some other
commodities.

Basis of Some of Economic Laws:

Several very important laws and concepts of

Economics arc based on the law of diminishing
marginal utility, e.g., the Law of Demand, the
concept of Consumer’s surplus, the concept of
Elasticity of demand, the Law of Substitution.
All these laws and concepts have ultimately
been derived from the Law of diminishing
Marginal Utility.

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