Law of Diminishing Marginal Utility:

Definition and Statement of the Law:

Thelaw of diminishing marginal utility/escribes a familiar an/ fun/amental ten/ency of human behavior. The
law of /iminishing marginal utility states that:

s a consumer consumes more an/ more units of a specific commo/ity, the utility from the successive units
goes on /iminishing.

7 H Gossen, a German economist, was first to explain this law in 1854. AIf7ed a7shaI later on restate/ this
law in the following wor/s:

The a//itional benefit which a person /erives from an increase of his stock of a thing /iminishes with every
increase in the stock that alrea/y has.

Law is Based Upon Th7ee Facts:

The law of /iminishing marginal utility is base/ upon three facts. Fi7st, total wants of a man are unlimite/ but each
single want can be satisfie/. s a man gets more an/ more units of a commo/ity, the /esire of his for that goo/
goes on falling. point is reache/ when the consumer no longer wants any more units of that goo/.SecondIy,
/ifferent goo/s are not perfect substitutes for each other in the satisfaction of various particular wants. s such
the marginal utility will /ecline as the consumer gets a//itional units of a specific goo/.Thi7dIy, the marginal utility
of money is constant given the consumer's wealth.

The basis of this law is a fun/amental feature of wants. t states that when people go to the market for the
purchase of commo/ities, they /o not attach equal importance to all the commo/ities which they buy. n case of
some of commo/ities, they are willing to pay more an/ in some less. There are two main reasons for this
/ifference in /eman/. (1) the linking of the consumer for the commo/ity an/ (2) the quantity of the commo/ity
which the consumer has with himself. The more one has of a thing, the less he wants the a//itional units of it. n
other wor/s, the marginal utility of a commo/ity /iminishing as the consumer gets larger quantities of it. This, in
brief, is the axiom of law of /iminishing marginal utility.

pIanation and ampIe of Law of Diminishing a7ginaI UtiIity:

This law can be explaine/ by taking a very simple example. Suppose, a man is very thirsty. He goes to the market
an/ buys one glass of sweet water. The glass of water gives him immense pleasure or we say the first glass of
water has great utility for him. f he takes secon/ glass of water after that, the utility will be less than that of the
first one. t is because the e/ge of his thirst has been blunte/ to a great extent. f he /rinks thir/ glass of water,
the utility of the thir/ glass will be less than that of secon/ an/ so on.

The utility goes on /iminishing with the consumption of every successive glass water till it /rops /own to zero.
This is the point of satiety. t is the position of consumer's equilibrium or maximum satisfaction. f the consumer is
force/ further to take a glass of water, it lea/s to /isutility causing total utility to /ecline. The marginal utility will
become negative. rational consumer will stop taking water at the point at which marginal utility becomes
negative even if the goo/ is free. n short, the more we have of a thing, ceteris paribus, the less we want still more
of that, or to be more precise.

n given span of time, the more of a specific pro/uct a consumer obtains, the less anxious he is to get more units
of that pro/uct or we can say that as more units of a goo/ are consume/, a//itional units will provi/e less
a//itional satisfaction than previous units. The following table an/ graph will make the law of /iminishing marginal
utility more clear.

ScheduIe of Law of Diminishing a7ginaI UtiIity:

Units TotaI UtiIity a7ginaI UtiIity

1st glass 20 20
2n/ glass 32 12
3r/ glass 40 8
4th glass 42 2
5th glass 42 0
6th glass 39 -3

From the above table, it is clear that in a given span of time, the first glass of water to a thirsty man gives 20 units
of utility. When he takes secon/ glass of water, the marginal utility goes on /own to 12 units; When he consumes
fifth glass of water, the marginal utility /rops /own to zero an/ if the consumption of water is force/ further from
this point, the utility changes into /isutility (-3).

Here it may be note/ that the utility of then successive units consume/ /iminishes not because they are not of
inferior in quality than that of others. We assume that all the units of a commo/ity consume/ are exactly alike.
The utility of the successive units falls simply because they happen to be consume/ afterwar/s.

u7;e/Diag7am of Law of Diminishing a7ginaI UtiIity:

The law of /iminishing marginal utility can also be represente/ by a /iagram.

n the figure (2.2), along OX we measure units of a commo/ity consume/ an/ along OY is shown the marginal
utility /erive/ from them. The marginal utility of the first glass of water is calle/ initial utility. t is equal to 20 units.
The MU of the 5th glass of water is zero. t is calle/ satiety point. The MU of the 6th glass of water is negative (-
3). The MU curve here lies below the OX axis. The utility curve MM
/
falls left from left /own to the right showing
that the marginal utility of the success units of glasses of water is falling.

Assumptions of Law of Diminishing a7ginaI UtiIity:

The law of /iminishing marginal utility is true un/er certain assumptions. These assumptions are as un/er:

i) RationaIity: n the car/inal utility analysis, it is assume/ that the consumer is rational. He aims at maximization
of utility subject to availability of his income.

ii) onstant ma7ginaI utiIity of money: t is assume/ in the theory that the marginal utility of money base/ for
purchasing goo/s remains constant. f the marginal utility of money changes with the increase or /ecrease in
income, it then cannot yiel/ correct measurement of the marginal utility of the goo/.

iii) Diminishing ma7ginaI utiIity: nother important assumption of utility analysis is that the utility gaine/ from
the successive units of a commo/ity /iminishes in a given time perio/.

i;) UtiIity is additi;e: n the early versions of the theory of consumer behavior, it was assume/ that the utilities
of /ifferent commo/ities are in/epen/ent. The total utility of each commo/ity is a//itive.

U = U
1

1
) + U
2

2
) + U
3

3
)... U
n

n
)

;) onsumption to be continuous: t is assume/ in this law that the consumption of a commo/ity shoul/ be
continuous. f there is interval between the consumption of the same units of the commo/ity, the law may not hol/
goo/. For instance, if you take one glass of water in the morning an/ the 2n/ at noon, the marginal utility of the
2n/ glass of water may increase.

;i) SuitabIe quantity: t is also assume/ that the commo/ity consume/ is taken in suitable an/ reasonable
units. f the units are too small, then the marginal utility instea/ of falling may increase up to a few units.

;ii) ha7acte7 of the consume7 does not change: The law hol/s true if there is no change in the character of
the consumer. For example, if a consumer /evelops a taste for wine, the a//itional units of wine may increase the
marginal utility to a /runkar/.

;iii) No change to fashion: ustoms an/ tastes: f there is a su//en change in fashion or customs or taste of a
consumer, it can than make the law inoperative.

i) No change in the p7ice of the commodity: there shoul/ be any change in the price of that commo/ity as
more units are consume/.

Limitations/ceptions of Law of Diminishing a7ginaI UtiIity:

There are some exceptions or limitations to the law of /iminishing utility.

i) ase of intoicants: onsumption of liquor /efies the low for a short perio/. The more a person /rinks, the
more likes it. However, this is truer only initially. stage comes when a /runkar/ too starts taking less an/ less
liquor an/ eventually stops it.

ii) Ra7e coIIection: f there are only two /iamon/s in the worl/, the possession of 2n/ /iamon/ will push up the
marginal utility.

iii) AppIication to money: The law equally hol/s goo/ for money. t is true that more money the man has, the
gree/ier he is to get a//itional units of it. However, the truth is that the marginal utility of money /eclines with
richness but never falls to zero.

Summing up, we can say that the law of /iminishing utility, like other laws of Economics, is simply a statement of
ten/ency. t hol/s goo/ provi/e/ other factors remain constant.

!7acticaI Impo7tance of Law of Diminishing a7ginaI UtiIity:

The law of /iminishing utility has great practical importance in economics. The law of /eman/, the theory of
consumer's surplus, an/ the equilibrium in the /istribution of expen/iture are /erive/ from the law of /iminishing
marginal utility.

i) Basis of the Iaw of demand: The law of marginal /iminishing utility an/ the law of /eman/ are very closely
relate/ to each other. n fact they law of /iminishing marginal utility, the more we have of a thing, an/ the less we
want a//itional increment of it. n other wor/s, we can say that as a person gets more an/ more of a particular
commo/ity, the marginal utility of the successive units begins to /iminish. So every consumer while buying a
particular commo/ity compares the marginal utility of the commo/ity an/ the price of the commo/ity which he has
to pay.

f the marginal utility of the commo/ity is higher than that of price, he purchases that commo/ity. s he buys more
an/ more, the marginal utility of the successive units begins to /iminish. Then he pays fewer amounts for the
successive units. He tries to equate at every step the marginal utility an/ the price of the commo/ity, he must
lower its price so that the consumers are in/uce/ to buy large quantities an/ this is what is explaine/ in the law of
/eman/. From this, we conclu/e that the law of /eman/ an/ the law of /iminishing are very closely inter-relate/.

ii) onsume7s su7pIus concept: The theory of consumer's surplus is also base/ on the law of /iminishing
marginal utility. consumer while purchasing the commo/ity compares the utility of the commo/ity with that of the
price which he has to pay. n most of the cases, he is willing to pay more than what he actually pays. The excess
of the price which he woul/ be willing to pay rather than to go without the thing over that which he actually /oes
pay is the economic measure of this surplus satisfaction. t is in fact /ifference between the total utility an/ the
actually money spent.

iii) Impo7tance to the consume7: consumer in or/er to get the maximum satisfaction from his relatively scare
resources /istributes his income on commo/ities an/ services in such a way that the marginal utility from all the
uses are the same. Here again the concept of marginal utility helps the consumer in arranging his scale of
preference for the commo/ities an/ services.

i;) Impo7tance to finance ministe7: Some times it is pointe/ out that the law of /iminishing marginal utility /oes
not apply on money. s a person collects money, the /esires to accumulate more money increases. This view is
superficial. t is true that wealth is acquire/ for the procurement of goo/s an/ services an/ man is always anxious
in getting more an/ more of money. But what about the utility of money to him? s it not a fact that as a person
gets more an/ more wealth, its utility progressively /ecreases, though it /oes not reach to zero?

For example, a person who earns $90,000 per month attaches less importance to $10. But a man who gets
$1000 per month, the value of $10 to him is very high. finance minister knowing this fact that the utility of money
to a rich man is high an/ to poor man low bases the system of taxation in such a way that the rich persons are
taxe/ at a progressive rate. The system of mo/ern taxation is therefore, base/ on the law of /iminishing marginal
utility.