The law of diminishing marginal utility is one of the vital laws of economics.
The law represents the fundamental tendency of human behavior.
According to the law, when a consumer increases the consumption of a good, there is a decline in MU derived from each successive unit of that good, while keeping the consumption of other goods constant.
In other words, as more and more of goods are consumed, the process of consumption at some point yields smaller and smaller additions to the utility. For example, an individual feels very hungry and decides to have golgappas. The first golgappa consumed by him/her gave maximum satisfaction to him/her. In such a case, on a 10-point scale, he would give ten points.
Thus, the utility derived from first unit of golgappa would be ten. His/her rate of satisfaction is best till eight points. After that, utility starts declining as he/she eats more and more golgappas; therefore, he may stop consuming golgappas. If he/she keeps mating golgappas, he/she may eventually reach a point at which eating golgappas would provide dissatisfaction to him/her. This would make utility zero or negative, leading to disutility.
This law applies to all kinds of consumer goods, such as durable and non-durable goods. The utility of a good is measureable in a quantitative term called utils. Let us now learn the law of diminishing marginal utility with the help of an example. Assume that a consumer only consumes good X.
Table-1 shows the total and marginal utility schedules for good X:
As shown in Table-1, TU increases as number of units consumed are increased till the fifth unit. At the fifth unit, TU has achieved its maximum level of 35 utils. Beyond this level, an additional unit consumed yields negative satisfaction for the consumer that results in decrease in total utility.
As per the law of diminishing marginal utility, Table-1 exhibits a decreasing trend as more and more units are consumed. The question arises why MU diminishes. This is because of the fact that the utility which is obtained from the good consumed depends on the need of the consumer for that good.
Generally, the intensity of the need falls as a consumer consumes more and more of a good. If additional units of a good give less satisfaction, then the customer would not be ready to pay a price for each unit consumed. In such a case, the customer would be willing to pay the lowest price for those additional units of goods as there is a decline in the utility.
Figure-2 shows the total utility and marginal utility curve:
In Figure-2, it can be seen that TU curve increases with an increase in number of units of good X. It reaches the saturation point when maximum level of 35 utils is achieved. After that, TU starts declining as fifth unit is consumed. In Figure-2, MU curve is decreasing as consumption of good X is increasing. At fifth unit, where TU is maximum, MU reaches zero and becomes negative. At this point, TU also starts falling.
The law of diminishing marginal utility is applied under certain conditions, called assumptions.
These assumptions of the law are shown in Figure-3:
The assumptions of the law of diminishing marginal utility (as shown in Figure-3) are discussed as follows:
i. Standard Unit:
Assumes that there must be a standard for the unit of a consumer good. For example, a cup of coffee, a pair of shoes, a glass of milk, and a plate of food.
ii. Consistency in consumer’s tastes:
Implies that the tastes and preferences of consumers must remain same during the consumption period. If the tastes of consumers change, the law may not hold.
iii. Continuity in consumption:
Implies that the consumption of a good should be continuous. In other words, this assumption states that the time interval between the consumption of units must be short.
Implies that the units of goods should be of standard size. For instance, it should be a glass of water rather than a spoon of water. If the size of a good is too small or large as compared to the standard size, the law may not hold.
Requires that the behavior and mental condition of the consumer should be normal during consumption period.
Limitations of Law of Diminishing Marginal Utility:
The law of diminishing marginal utility forms the basis for various other economic laws. Moreover, it is helpful for consumers to decide their expenditure. However, the law of diminishing marginal utility suffers from limitations.
Some of the important limitations of the law are discussed as follows:
i. Unrealistic assumptions:
Include homogeneity, continuity, and constancy conditions. All these assumptions are impossible to find at once.
ii. Inapplicability to certain goods:
Implies that the law of diminishing marginal utility cannot be applied to goods, such as television and refrigerator. This is because the consumption of these goods is not continuous in nature.
iii. Constant marginal utility of money:
Assumes that MU of money remains constant, which is unrealistic. There is also a gradual decline in the MU of money.
iv. Change in other people’s stock:
Implies that the utility of consumers is also dependent on what other people have in their stock. Thus, the utility depends on social needs.
v. Other possessions:
Assumes that utility of consumers also depends on possessions already owned by them. For example, a consumer is suffering from diabetes, thus, he is not allowed to consume sugar that he/she already possesses. In such a case, the utility of coffee derived by him/her would be less.
Exceptions to the Law of Diminishing Marginal Utility:
The law of diminishing marginal utility states that as more and more of goods are consumed, the utility derived from them falls. However, there is an exception to this law. It is observed that a consumer sometimes gain more utility as more and more of a good is consumed.
These exceptions are discussed as follows:
Implies that the law of diminishing marginal utility is violated in case of hobbies of an individual, such as stamp collection and coin collection. This is because an individual derives more and more utility from additional unit gained from a hobby item. For instance, a level of satisfaction increases when a new variety of stamps or coins are received. However, the utility diminishes if the same variety of stamps or coins is gained every time.
Implies that the law of diminishing marginal utility cannot be applied to misers. This is because they derive more and more utility from more and more of any good.
Utility is a feeling of satisfaction, pleasure, or happiness. The demand of a good depends on the amount of utility derived by a consumer from that good. Therefore, it is necessary to measure utility to determine the demand of goods or services.