Law of Diminishing Marginal Utility

Utility explains that as a person consumes an item or a product, the satisfaction or utility that they derive from the product wanes as they consume more and more of that product. For example, an individual might buy a certain type of chocolate for a while. Soon, they may buy less and choose another type of chocolate or buy cookies instead because the satisfaction they were initially getting from the chocolate is diminishing.
In economics, the law of diminshing margial utility states that the marginal utility of a good or service declines as its available supply increases. Economic actors devote each successive unit of the good or service towards less and less valued ends. The law of diminishing marginal utility is used to explain other economic phenomena, such as time preference.
The Law of Diminishing Marginal Utility Explained
Whenever an individual interacts with an economic good, that individual acts in a way that demonstrates the order in which they value the use of that good. Thus, the first unit that is consumed is dedicated to the individual’s most valued end. The second unit is devoted to the second most valued end, and so on. In other words, the law of diminishing marginal utility postulates that when consumers go to market to purchase a commodity, they do not attach equal importance to all the commodities they buy. They will pay more for some commodities and less for others.
As another example, consider an individual on a deserted island who finds a case of bottled water that washes ashore. That person might drink the first bottle indicating that satisfying their thirst was the most important use of the water. The individual might bathe themselves with the second bottle, or they might decide to save it for later. If they save it for later, this indicates that the person values the future use of the water more than bathing today, but still less than the immediate quenching of their thirst. This is called ordinal time preference. This concept helps explain savings and investing versus current consumption and spending.
The Law Applied to Money and Interest Rates
The example above also helps to explain why demand curves are downward-sloping in microeconomic models since each additional unit of a good or service is put toward less valuable ends. This application of the law of marginal utility demonstrates why a rise in the money stock (other things being equal) reduces the exchange value of a money unit since each successive unit of money is used to purchase a less valuable end.
The monetary exchange example provides an economic argument against the manipulation of interest rates by central banks since the interest rate affects the saving and consumption habits of consumers or businesses. Distorting the interest rate encourages consumers to spend or save according to their actual time preferences, leading to eventual surpluses or shortages in capital investment.
The Law and Marketing
Marketers use the law of diminishing marginal utility because they want to keep marginal utility high for products that they sell. A product is consumed because it provides satisfaction, but too much of a product might mean that the marginal utility reaches zero because consumers have had enough of a product and are satiated. Of course, marginal utility depends on the consumer and the product being consumed.
1] The Cardinal Measurability of Utility
This theory states that utility is a cardinal concept. In other words, it is measurable and quantifiable. Hence, you can say that you derive a utility of 10 units from consuming 1 unit of commodity A and 5 from consuming 1 unit of commodity B. This can help you compare different commodities and analyze which commodity offers better utility or satisfaction.
The theory further states that money is the measuring rod of utility. So, the amount of money that you are willing to spend for a unit of commodity rather than going without it is the measure of utility that you derive from the said commodity.
2] The constancy of the Marginal Utility of Money
The second assumption is that when you are spending money on a commodity, the marginal utility of money remains constant throughout. This facilitates the measurement of the utility of commodities in terms of money.
3] The Hypothesis of Independent Utility
This theory ignores the complementarity between goods. It states that the total utility that you get from a collection of goods is a simple sum total of the separate utilities of each good.
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.

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