Law of Diminishing Marginal Utility - An Overview

The law of diminishing marginal utility says that all other things being equal, as consumption rises, the marginal utility gained from each extra unit decreases. 

 

The incremental gain in utility that follows from the consumption of one more unit is known as marginal utility. The phrase "utility" is an economic term for "satisfaction" or "happiness."

 

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Income and wealth have diminishing marginal utility, implying that as income rises, individuals enjoy a proportionately lesser increase in contentment and pleasure. 

 

Three bites of sweets, for example, are preferable to two bites, but the twentieth bite adds little to the experience beyond the nineteenth (and could even make it worse).

 

"More money may not make you happy," to put it more simply.

 

In his Principles of Economics, Alfred Marshall popularised the notion of decreasing marginal value (1890)

 

“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”

– Alfred Marshall, Principles of Economics

 

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Marginal Utility vs. Total Utility

 

Total Utility is an aggregate measure of consumer satisfaction, whereas Marginal Utility is a measure of the change in consumer satisfaction as a result of a change in consumption.

 

MU(x) = TU(x) – TU(x – 1)

 

The difference between the total utility gained from x units of consumption and the total utility obtained from x–1 units of consumption is the Marginal Utility earned from the xth unit of consumption.
 

Watch this video on: Diminishing Marginal Utility

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Getting an Idea of Diminishing Marginal Utility

 

According to the law of decreasing marginal utility, when individuals use more units of a commodity or service, the value (or utility) they receive from each unit declines. There are two kinds of users to consider:

 

The sum of all the benefits a consumer receives from utilizing a product or service is referred to as total utility.

 

The difference in overall pleasure that results from consuming more of a product is known as marginal utility. Let's assume a can of soda provides a consumer with 20 total utility "points" or "units." The marginal utility of the drink would be 5 points if drinking a second can increase overall utility to 25 points.

 

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According to the law of diminishing marginal utility, each extra Soda drunk in the real world gives the customer less marginal benefit than the one before it. 

 

If you drink one soda and get 20 units of the total value, the second soda you drink will be somewhat less valuable (say, 15 points), giving you a total value of 35. A third will be much less valuable (say, 10 points). 

 

To put it another way, each new beverage has a lower marginal utility than the previous one.

 

Keep in mind that "utility" is a subjective metric. For example, there is no universal benefit in eating one piece of pizza. 

 

Each person will place a different value on a product or service. Consider utility as a theoretical tool used by economists to investigate the worth and advantages that various products and services provided to customers.

 

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Is it possible for goods to have increasing marginal utility?

 

The marginal utility of a good may arise in some situations. If you're making a three-legged stool, for example, the third leg is more valuable than the first two since the stool wouldn't be functional without all three.

 

Similarly, if you're creating a deck of playing cards, each card you uncover will provide additional usefulness until the pack is full. 

 

The more cards you uncover, the more full your deck will be, and you will be closer to playing a card game. According to this argument, if a deck contains 52 cards, a deck of 45 cards is worth more than a deck of 32.

 

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Types of Marginal Utility

 

There are several different types of marginal utility. The following are three of the most common ones:

 

Positive Marginal Utility

 

When having more of something makes you happier, it's called positive marginal utility. Let's say you enjoy eating a slice of cake, but you think a second slice would be even better. Then eating cake provides you with a positive marginal value.

 

Zero Marginal Utility

 

When you consume more of something and get no more enjoyment, you have reached zero marginal utility. For example, two slices of the cake could make you feel very full, and a third slice wouldn't make you feel any better. In this situation, consuming cake provides you with no marginal benefit.

 

Negative Marginal Utility

 

It refers to a situation when you have too much of something, it's really harmful to consume more of it. After eating three pieces of cake, for example, the fourth slice of cake may potentially make you ill.

 

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What is the significance of Diminishing marginal utility?

 

Many microeconomic scenarios, such as the value of a product or a consumer's preferences, are explained by the rule of decreasing marginal utility.

 

• Decreasing marginal utility, for example, can assist explain how the law of demand works. In most economic models of demand, a product's demand curve has a negative slope, meaning that as its price rises, demand falls, and vice versa. 

 

If every unit of a commodity provided the same usefulness, demand would grow inexorably as the price decreased.

 

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To put it another way, if the price were to fall to zero, demand would theoretically become limitless if the law of decreasing marginal utility did not apply. If a good was free and each unit had the same worth, you'd naturally desire an unlimited supply. 

 

Let's pretend you're a basketball player. You would desire an unlimited amount of basketballs if they were free and their worth never decreased from one unit to the next. You would feel like you could never have too many.

 

• The diminishing marginal utility also explains why a customer chooses to buy a product or service. If each new unit of a product had the same worth as the first, a consumer might theoretically spend all of their money on as much of that commodity as feasible. 

 

In the actual world, however, customers choose to spend their money on whatever provides the most marginal value at the time.

 

Food and water, for example, are essentials that offer a customer a high value or utility. That is until the customer receives sufficient food and water to meet their bodily requirements. The marginal utility of these items would fall after they met this demand. The customer may then opt to acquire other items with higher marginal value.

 

The rule of declining marginal utility may be used in a variety of ways, including assisting economists and governments in evaluating changes in a country's economy. 

 

If a government wishes to assist the economy as a whole, it could opt to provide more money to the poor since they will get more bang for their buck. A person with $5,000 will place a higher value on each additional dollar than someone with $100,000.

 

Read this study on “Diminishing Marginal Utility of Wealth Cannot ExplainRisk Aversion”

 

Bottom Line: The Economics of Happiness

 

This concept raises a number of significant concerns, not the least of which is the economics of happiness. Are the wealthiest countries the happiest? Are those who have the most money and riches happier than those who have the least? Is it true that having more money and wealth makes you happier?

 

The question may be different for each person. Pick a millionaire, and their attitude toward money is likely to be quite different. However, it provides a compelling case for progressive taxes and income redistribution.