Distinction between Supply and Stock. Here, it seems necessary that the meaning of the term “supply” and “stock” may be made clear as they are often confused by the readers. “Supply” refers to that quantity of the commodity which is actually brought into the market for sale at a given price per unit of time. While “stock” is meant the total quantity of a commodity which exists in a market and can be offered for sale at a short notice.
The supply and stock of a commodity in the market may or may not be equal. If the commodity is perishable, (Ike vegetables, fruits, fish, etc., and then the supply and the stock is generally the same. But in case of a product which is storable, the position is quite different. If the producer finds that the price of his product is low as compared to its cost of production, he tries to withhold the entire or a part of the stock. In case of a favorable price, the producer may dispose off larger quantities or the entire stock of his commodity; it will all depend upon his own valuation of the commodity at that particular time.

Willingness and Ability to pay: Demand is the amount of a commodity for which a consumer has the willingness and also the ability to buy.

Demand is always at a price: If we talk of demand without reference to price, it will be meaningless. The consumer must know both the price and the commodity. He will then be able to tell the quantity demanded by him.

Demand is always per unit of time: The time may be a day, a week, a month, or a year. We can say that by demand is meant the amount of the commodity that buyers are able and willing to purchase at any given price over some given period of time. Demand is also described as a schedule of how much a good people will purchase at any price during a specified period of time.

The concept of marginal rate of substitution (MRS) was introduced by Dr. J.R. Hicks and Prof. R. G. D. Allen to take the place of the concept of Diminishing Marginal Utility. Allen and Hicks are of the opinion that it is unnecessary to measure the utility of a commodity. The necessity is to study the behavior of the consumer as to how he prefers one commodity to another and maintains the same level of satisfaction.

For example, there are two goods X and Y which are not perfect substitute of each other. The consumer is prepared to exchange good X for Y. How many units of Y should be given for one unit of X to the consumer so that his level of satisfaction remains the same? The rate or ratio at which goods X and Y are to be exchanged is known as the marginal rate of substitution. In the words of Hicks “The marginal rate of substitution of X for Y measures the number of units of Y that must be sacrificed for unit of X gained so as to maintain a constant level of satisfaction”.

Marginal rate of substitution (MRS) can also be defined as “the ratio of exchange between small units of two commodities, which are equally valued or preferred by a consumer”. It may here be noted that the marginal rate of substitution (MRS) is the
personal exchange rate of the consumer in contrast to the market exchange rate.

A graph showing a whole set of indifference curves is called an indifference map. In the given figure three indifference curves IC¹, IC² and IC³ have been shown. The various combination of goods of wheat and rice lying on IC¹ yield the same level of satisfaction to the consumer. The combination of goods lying on higher indifference curve IC² contain more of both the goods wheat and rice. The indifference curve IC² gives more satisfaction to the consumer than IC¹. Similarly, the set of combination of two goods on IC³ yields still higher satisfaction to the consumer than IC². In short, the farther away a particular curve is from the origin, the higher the level of satisfaction it represents.

It may here be noted that while an indifference curve shows all those combination of wheat and rice which provide equal satisfaction to the consumer but it does not indicate exactly how much satisfaction is derived by the consumer from these combination. It is because of the fact that the concept of ordinal utility does not involve the quantitative measurement of utility.

The consumer’s preferences can be shown in a diagram with an indifferences curve. The indifferences curve shows nothing about the absolute amounts of satisfaction obtained. It merely indicates a set of consumption bundles that the consumer views as being equally satisfactory.

In the given figure, we measure the quantity of wheat along X-axis (in kilograms) and along OY-axis, the quantity of rice (in kilograms). 1C is an indifference curve. It is shown in the diagram that a consumer may buy 12 kilograms of rice and 5 kilograms of wheat or 9 kilograms of rice and 15 kilograms of wheat. Both these combinations are equally preferred by him and he is indifferent to these two combinations. When the scale of preferences of the consumer is graphed, by joining the points a, b, c, d, e, we obtain indifference Curve IC. Every point on indifference curve represents a different combination of the two goods and the consumer is indifferent between any two points on the indifference curve. All the combinations are equally desirable to the consumer. The consumer is Indifferent as to which combination he receives. The indifference curve IC thus is a locus of different combinations of two goods which yield the same level of satisfaction.

The indifference curve indicates the various combinations of two goods which yield equal satisfaction to the consumer. By definition, an indifference curve shows all the various combinations of two goods that give an equal amount of satisfaction to a consumer. The indifference curve analysis approach was first introduced by Slustsky, a Russian economist in 1915. Later on it was developed by J.R. Hicks and R.G.D. Allen in the year 1928. These economists are of the view that it is wrong to base the theory of consumption on two assumptions; (i) that there is only one commodity which a person will buy at one time, and (ii) the utility can be measured. Their point of view is that utility is purely subjective and is immeasurable. Moreover an individual is interested in a combination of related goods and not in the purchase of one commodity at one time. So they base the theory of consumption on the scale of preference. According to the ordinal theorists, a consumer simply ranks or orders his Preferences. It is only an expression of the consumer’s preference for one commodity over another The ordinal utility theory or the indifference curve analysis is based on four main assumptions:

Assumptions of Indifference Curve Analysis:

(1) Rational behavior of the consumer. It is assumed that individuals are rational in making decisions from their expenditures on consumer goods.

(2) Utility is ordinal. Utility cannot be measured cardinally. It can be, however, expressed ordinally. In other words, the consumer can rank his various combinations of goods according to the satisfaction or utility of each basket.

(3) Diminishing marginal rate of substitution. In the indifference curve analysis, the principle of diminishing marginal rate of substitution is assumed.

(4) Consistency in choice: The consumer, it is assumed, is consistent in his behavior during a period of time. For instance, if the consumer prefers combination of A of goods to combination B of goods, he then remains consistent in his choice. His preference, during another period of time does not change. Symbolically, it can be expressed as: If A> B, then

B>A

(5) Consumer’s preferences not self contradictory. The consumer’s preferences are not self contradictory. means that if combination A is preferred over combination B and combination B is preferred over C, then combination A is preferred over C. Symbolically it can be expressed, If A

> B and B > C, then A> C.

(6) Goods Consumed are substitutable. The goods consumed by the consumer are substitutable. The utility can be maintained at the same level by consuming more of some goods and less of the, other. There are many combinations of the two commodities which are equally preferred by a consumer and he is indifferent as to which of the two he receives. For example, a person has a limited amount of income which he wishes to spend on two commodities, rice and wheat. Let us suppose that the following commodities are equally valued by him:

It is a matter of indifference for the consumer as to which combination he buys. He may buy 16 kilograms of rice and 2 kilograms of wheat or 9 kilograms of rice and 15 kilograms of wheat. All these combinations are equally preferred by him. An indifference curve thus is composed of a set of consumption alternatives each of which yields the same total amount of satisfaction. These combinations can also be shown by an indifference curve.

Assumptions

(1) Utility is cardinally measurable.

(2) Utilities of different commodities are independent

(3) The marginal utility of money to the consumer remains constant.

(4) Utility gained from the successive units of a commodity diminishes.

(i) Derivation of demand curve in the case of a single commodity; Law of diminishing marginal utility.

Dr. Alfred Marshall derived the demand curve with the aid of law of diminishing marginal utility. The law of diminishing marginal utility states that as the consumer purchases more and more units of a commodity, he gets less and less utility from the successive units of expenditure. At the same time, as the consumer purchases more and more units of one commodity, then lesser and lesser amount of money is left with him to buy other goods and services. A rational consumer, therefore, while purchasing a commodity compares the price of the commodity which he has to pay with the utility of the commodity he receives from it. So long as the marginal utility of a commodity is higher than its price MU_x > P_x, the consumer would demand more and more units of it till its marginal utility is equal to its price MU_x = P_x or the equilibrium condition is established. To put it differently, as the consumer consumes more and more units of a commodity, its marginal utility goes on diminishing. So it is only at a diminishing price at which the consumer would like to demand more and more units of a commodity.

In figure the Mu_x is negatively sloped. It shows that as the consumer acquires larger quantities of good x, its marginal utility diminishes. Consequently, at diminishing price, the quantity demanded of the good x increases as is shown in figure. At x, quantity the marginal utility of a good is Mu¹. This is equal to p¹ by definition. The consumer here demands Ox¹ quantity of the commodity at P¹ price. In the same way x² quantity of the good is equal to p². Here at P² price, the consumer will buy ox² quantity of commodity. At x³ quantity the marginal utility is Mu³, which is equal to p³. At p³, the consumer will buy ox³ quantity and so on.

We conclude from above, that as the purchase of the units of commodity x are increased, its marginal utility diminishes. So at diminishing price the quantity demanded of good x increases as is evident from figure. The rationale supports the notion of down sloping demand curve that when price falls, other things remaining the same, the quantity demanded of good increases and vice verse. (The negative section of the MU curve does not form part of the demand curve, since negative quantities do not make sense in economics).

(ii) Derivation of the demand curve in the case of two or more than two commodities: Law of equimarginal utility

The law of diminishing marginal utility can also be applied in case of two or more than two goods. When a consumer has to spend a certain given income on a number of goods, he attains maximum satisfaction when the marginal utilities of the goods are proportional to their prices as stated below.

Derivation of Demand Curve

In the figure, given the money income, the price of x commodity (P_x) and the price of Y commodity (P_y) and constant marginal utility of money (MU_m), the demand curve derived is illustrated. The consumer allocates his money income between X and Y commodities to get OQ¹ units of good x and OY unit of good Y commodities because the combination corresponds to at the OM level (constant).

Let us assume that money income and the price of Y commodity remain constant but the price of X commodity decreases. As a result of this money expenditure on commodity X rises resulting

curve to shift towards right. The consumer now allocates his income to OQ₂ quantity of X commodity and OY quantity of Y commodity because the combination corresponds to (constant) at OM level.

Thus in response to decrease in the price from Px to Px¹, the quantity demanded of a good X increases from OQ¹ to OQ². The DD? is a negatively sloped demand curve.

 The principle of equal marginal utility occupies an important place in the cardinal utility analysis. According to this, a consumer is in equilibrium when he distributes his given money income among various goods in such a way that marginal utility derived from the last rupee spent on each good is the same. The Marshallian approach to consumer’s equilibrium is based on the following assumptions.

 Assumptions

 The main assumptions of the law of equi-marginal utility are as under:

 (1)    Independent utilities. The marginal utilities of different commodities are independent of each other and diminishes with more and more purchases.

(2)    Constant marginal utility of money. The marginal utility of money remains constant to the consumer as he spends more and more of it on the purchases of goods.

(3)    Utility is cardinally measurable.

(4)    Every consumer is rational in the purchase of goods.

(5)    Limited money income. A consumer has limited amount of money income to spend.

Definition and expLanation of the law:

 The law of equi-marginal utility is simply an extension of the law of diminishing marginal utility to two or more than two commodities. The law of equi-marginal, is known, by various names. It is named as the Law of Substitution, the Law of Maximum Satisfaction, the Law of Indifference, the Proportionate Rule and the Gossen’s Second Law. In cardinal utility analysis, this law is stated by Lipsey in the following words. “The household maximizing the utility will so allocate the expenditure between commodities that the utiliIity of the last penny spent on each item is equal”. As we know, every consumer has unlimited wants. However, the income at his disposal at any time is limited. The consumer is therefore, faced with a choice among many commodities that he can and would like to pay. He therefore, consciously or unconsciously compares the satisfaction which he obtains from the purchase of the commodity and the price which he pays for it. If he thinks the utility of the commodity is greater than the utility of money, he buys that conmodity. As he buys more and more of that comniodity, the utility of the successive units begins to diminish. He stops further purchase of the commodity at a point where the marginal utility of the commodity and its price are just equal. If he pushes the purchase further from his point of equilibrium, then the marginal utility of the commodity will be less than that of price and the household will be a loser. A consumer will be in equilibrium with a single commodity symbolically when:

 Consumer’s equilibrium with two or more than two goods purchased. A prudent consumer in order to get the maximum satisfaction from his limited means compares not only the utility of a particular commodity and the price but also the utility of the other commodities which he can buy with his scarce resources. If he finds that a particular expenditure in one use is yielding less utility than that of other, he will try to transfer a unit of expenditure from the commodity yielding less marginal utility to commodity yielding higher marginal utility. The consumer will reach his equilibrium position when it will not be possible for him to increase the total utility by transferring expenditure from less advantageous uses to more advantageous uses.

 The consumer will maximize total utility from his given income when the utility from the last rupee spent on each good is the same. Algebrically, this is

when;  Here (a), (b), (c), … n are large number goods consumed.

 It may here be noted that when a consumer is in equilibrium there is no way to increase utility by reallocating his given money income.

 The doctrine of equi-marginal utility can be explained by taking an example. Suppose a person has Rs.5 with him which he wishes to spend on two commodities, tea and cigarettes. The marginal utility derived from both these commodities is as under:

 (1)    Rs. 5.00 may be spent on tea only

(2)    Rs. 5.00 may be utilized for the purchase of cigarettes only.

(3)    Some rupees may be spent on the purchase of tea and some on the purchase of cigarettes.

 If the prudent consumer spends Rs. 5.00 on the purchase of tea, he gets 30 utility. If he spends Rs. 5.00 on the purchase of cigarettes, the total utility derived is 39 which is higher than tea. In order to make the best of the limited resources, he adjusts his expenditure.

 (1)    By spending Rs. 4.00 on tea and Rs. 1.00 on cigarettes, he gets 40 utility (10+8+6+4+12=40).

(2)    By spending Rs. 3.00 oa tea and Rs. 2.00 on cigarettes, he derives 46 Utility (10+8+6+12+10=46).

(3)    By spending Rs. 2.00 on tea and Rs. 3.00 on cigarettes, he gets 48 utility (10+8+12+10+8=48).

(4)    By spending Rs. 1.00 on tea and Rs. 4.00 on cigarettes, he gets 46 utility (10+12+10+8+6=46).

 The sensible consumer will spend Rs. 2.00 on tea and Rs. 3.00 on cigarettes and will get the maximum satisfaction. When he spends Rs. 2.00 on tea and Rs. 3.00 on cigarettes, the marginal utility derived from both these commodities is equal to 8. When the marginal utilities of the two commodities are equalized, the total utility is then maximum i.e., 48 as is clear from the schedule given above.

 The law of equi-marginal utility can be explained with the help the diagrams.

In the diagram, MU is the marginal utility curve for tea and KL of cigarette. When a consumer spends OP amount (Rs.2) on tea and OC (Rs.3) on cigarettes, the marginal utility derived from the consumption of both the items (Tea and Cigarettes) is equal to 8 units (EP=NC). The consumer gets the maximum utility when he spends Rs. 2.00 on tea and Rs. 3.00 on cigarettes and by no other alteration in the expenditure.

 We now assume that the consumer spends Rs. 1.00 on tea (OC’ amount) and Rs. 4.00 (OQ’) on cigarettes. If CQ’ more amount is spent on cigarettes, the added utility is equal to the area CQ’ N’N. On the other hand, the expenditure on tea falls from OP amount (Rs.2) to OC’ amount (Rs. 1.00). There is a toss of utility equal to the area C’PEE’. The loss in utility (tea) is greater than that of its gain in cigarettes. The consumer is not deriving maximun satisfaction except the combination of expenditure of Rs. 2.00 on tea and Rs. 3.00 on cigarettes.

 This law is known as the Law of Maximum Satisfaction because a consumer tries to get the maximum satisfaction from his limited resources by so planning his expenditure that the marginal utility of a rupee spent in one use is the same as the marginal utility of a rupee spent on another use. It is known as the Law of Substitution because consumer continues substituting one good for another till he gets the maximum satisfaction. It is called the Law of Indifference because the maximum satisfaction has been achieved by equating the marginal utility in all the uses. The consumer then becomes indifferent to read just his expenditure unless some change fakes place in his income or the prices of the commodities, etc.

 Limitations of the Law

 (i)     Effect of fashions and customs. The law of equi-marginal utility may become inoperative if people forced by fashions and customs spend money on the purchase of those commodities which they clearly know yield less utility but they cannot transfer the unit of money from the less advantageous uses to the more advantageous uses because they are forced by the customs of the country.

(ii)   Ignorance or Carelessness. Sometimes people due to their ignorance of price or carelessness to weigh the utility of the purchased commodity do not obtain the maximum advantage by equating the marginal utility in all the uses.

(iii) Indivisible Units. If the unit of expenditure is not divisible, then again the law may become inoperative.

(iv)  Freedom to Choose. If there is no perfect freedom between various alternatives, the operation of law may be impeded;

 Importance of the law

The Law of equi-marginal utility is of great practical importance. The application of the principle of substitution extends over almost every field of economic enquiry. Every consumer consciously or unconsciously trying to get the maximum satisfaction from his limited resources acts upon this principle of substitution. Same is the case with the producer. In the field of exchange and in theory of distribution too, this law plays a vital role. In short, despite its limitation, the law of maximum satisfaction is meaningful general statement of how consumers behave.

 In addition to its application to consumption, it applies equally to the theory of production and theory of distribution. In the theory of production, it is applied on the substitution of various factors of production to the point where marginal return from all the factors are equal. The government can also use this analysis for evaluation of its different economic prices.

The equal marginal rule also guides an individual in the spending of his saving on different types of assets. The law of equal marginal utility also guides an individual in the allocation of his time between work and leisure. In short, despite limitations the law of substitution is applicable to all problems of allocation of scarce resources.

The law of diminishing marginal utility describes a familiar and fundamental tendency of human behaviour. The law of diminishing marginal utility states that, “as a consumer consumes more and more units of a specific commodity, the utility from the successive units goes on diminishing”. Mr. H. Gossen, a German economist, was the first to explain this Law in 1854. Alfred Marshall later on restated this Law in the following words: “The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that he already has”. The basis of this Law is a fundamental feature of wants. It states that when people go to the market for the purchase of commodities, they do not attach equal importance to all the commodities which they buy. In case of some of commodities, they are willing to pay more and in some less. There are two main reasons for this difference in demand. (1) the liking of the consumer for the commodity and (2) the quantity of the commodity which the consumer has with himself. The more one has of a thing, the less he wants the additional units of it. In other words, the additional utility of a commodity diminishes as the consumer gets larger quantities of it. The law thus states that as the more of a good an individual consumes per period of time, the smaller is the increase in total utility, other things remaining constant.

Law based upon three facts:

                The law of diminishing utility is based upon three facts. First, total wants of a man are unlimited but each single want can be satisfied. As a man gets more and more units of a commodity, the desire of his want for that good goes on falling. A point is reached when the consumer no longer wants any more units of that good, Secondly, different goods are not perfect substitutes for each other in the satisfaction of various particular wants. As such the marginal utility will decline as the consumer gets additional units of a specific good. Thirdly, there is no change in the tastes of the consumers. 

 Explanation of the Law:

                The law can be explained by taking a simple example. Suppose a person is thirsty and the price of water is zero. He takes one glass of water which gives him great satisfaction. We can say the first glass of water has great utility for him. He then takes second glass of water. The utility of the second glass of water is less than that of first glass of water. The utility declines because the edge of his thirst has been blunted to a great extent. If he drinks third glass of water, the utility of the third glass will be less than that of second and so on. The utility goes on diminishing with the consumption of every successive glass of water till it drops down to zero. This is the point of satiety. It is the position of consumer’s equilibrium or maximum satisfaction. If the consumer is forced further to take a glass of water, it leads to disutility causing total utility-to decline. The marginal utility will become negative. A rational consumer will stop taking water at the point at which marginal utility becomes negative even if the good is free. In short, when a good is free, a consumer increases consumption of a good so long its additional units provide him positive marginal utility. The following table and graph will make the law of diminishing marginal utility more clear.

 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 second glass of water, the marginal utility goes down to 12 units. When he consumes fifth glass of water, the marginal utility drops down to zero and if the consumption of water is forced further from this point, the utility changes into disutility (–3). Here it may be noted that the utility of the successive units consumed diminishes not because they are of inferior in quality than that of others. We assume that all the units of a commodity consumed are exactly alike. The utility of the Diminishing successive units falls simply because they happen to be consumed afterwards.

The law of diminishing utility can also be represented by a diagram.

 In figure, along OX we measure units of a commodity consumed and along OY is shown the marginal utility derived from them. The marginal utility of the first glass of water is called initial utility. It is equal to 20 units. The MU of the 5^th glass of water is zero. It is called the satiety point. The MU of the 6^th glass of water is negative –3. Tie MU curve here lies below the OX axis. The utility curve MM falls from left down to the right showing tha,the marginal utility of the success units of glasses of water is falling.

 When a good is scarce and so priced the consumer will increase the consumption of a commodity upto the extent where his marginal utility for the good equals the price which he has to pay, i.e. Mu = P.

 Assumptions of the Law:

                The law of diminishing utility is true under certin assumptions. These assumptions are as under: 

1. Rationality. In the cardinal utility analysis, it is assumed that the consumer is rational. He aims at maximization of utility subject to availability of his income.
2. Constant marginal utility of money. It is assumed in the theory that the marginal utility of money used for purchasing goods remains constant. If the marginal utility of money changes with the increase or decrease in income, it then cannot yield correct measurement of the marginal utility of the good.
3. Diminishing marginal utility. Anohér important assumption of utility analysis is that the utility gained from the successive units of a commodity diminishes in a given time period.
4. UTILITY is additive. In the earIy versions of the theory of consumer behaviour, it was assumed that the utilities of different commodities are independent. The total utility of each commodity is additive.

1. Consumption to be continuous. It is assumed in this law that the consumption of a commodity should be continuous. If there is interval between the consumption of the same units of the commodity, the law may not hold good. For instance, if you take one glass of water in the morning and the 2^nd at noon, the marginal utility of the 2^nd glass of water may increase.
2. Suitable quantity of a commodity. It is also assumed that the commodity consumed is taken in suitable and reasonable units. If the units are too small, then the marginal utility instead of falling may increase upto a few units.
3. Character of the consumer does not change. The law holds true if there is no change in the character of the consumer. For example, if a consumer develops a taste for Wine, the additional units of wine may increase the marginal utility to a drunkard.
4. No change to fashions, customs, tastes. If there is a sudden change in fashion or customs or tastes of a consumer, it can then make the law in operative.
5. No change in the price of the commodity. There should be no change in the price of that commodity as more units are consumed.

 Limitations of the law:

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

 (1)    Case of intoxicants. Consumption of liquor defies the law for a short period. The more a person drinks, the more he likes it. However, this is true only initially. A stage comes when a drunkard too starts taking less and less liquar and eventually stops it.

(2)    Rare collections. If there are only two diamonds in the world, the possession of 2^nd diamond will push up the marginal utility.

(3)    Application to money. The law equally holds good for money. It is true that more money the man has the more greedy he is to get additional units of it. However, the truth is that the marginal utility of money declines with richness but never falls to zero.

 Summing up, we can say that the law of diminishing utility, like other laws of Economics, is simply a statement of tendency. It holds good provided other factors remain constant.

 Practical Importance of the law of Diminishing Utility:

                The law of diminishing marginal utility has great practical importance in Economics. The law of demand, the theory of consumer’s surplus, the equilibrium in the distribution of expenditure are derived from the law of diminishing marginal utility.

1. Basis of the law of demand. The law of diminishing marginal utility and the law of demand are very closely related to each other. In fact the law of diminishing utility is the basis of the law of demand. According to the law of diminishing utility, the more we have of a thing, the less we want additional increment of it. In other words, we can say that as a person gets more and more of a particular commodity, the marginal utility of the successive units begins to diminish. So every consumer while buying a particular commodity compares the marginal utility of the commodity and the price of the commodity which he has to pay. If the marginal utility of the commodity is higher than that of price, he purchases that commodity. As he buys more and more, the marginal utility of the successive units begins to diminish. Then he pays less amount for the successive units. He tries to equate at every step the marginal utility and the price of the commodity. From this it is clear that if a person wishes to increase the sale of a commodity, he must lower its price so that the consumers are induced to buy large quantities and this is what is explained in the law of demand. From this, we conclude that the law of demand and the law of diminishing marginal utility are very closely inter-related.
2. Consumer’s Surplus Concept. The theory of consumer’s surplus is also based on the law of diminishing marginal utility. A consumer while purchasing the commodity compares the utility of the commodity with that of the price which he has to pay. In most of the cases, he is willing to pay more than what he actually pays. The excess of the price, which he would be willing to pay rather than to go without the thing over, that which he actually does pay, is the economic measure of this surplus satisfaction. It is in fact the difference between the total utility and the actually money spent.
3. Importance to the consumer. A consumer in order to get the maximum satisfaction from his relatively scarce resources distributes his income on commodities and 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 preferences for the commodities and services.
4. Importance to finance minister. Sometimes it is pointed out that the law of diminishing marginal utility does not apply on money. As a person collects money, the desire to accumulate more money increases. This view is superficial. It is true that wealth is acquired for the procurement of goods and services and man is always anxious in getting more and more of money. But what about the utility of money to him? Is it not a fact that as a person, gets more and more wealth, its utility pregressively decreases, though it does not reach to zero. For example, a person who earns Rs.9,000.00 per month attaches less importance to Rs.10. But a man who get Rs.1000 per month, the value of Rs.10 to him is very high. A finance minister knowing this fact that the utility of money to a rich man is high and to a poor man low bases the system of taxation in such a way that the rich persons are taxed at a progressive rate. The system of modern taxation is therefore, based on the law-of diminishing marginal utility.

People buy goods because they get satisfaction from them. This satisfaction which the consumer experiences when he consumes a good, when measured as number of utils, is called utility. It is here necessary to make distinction between total utility and marginal utility.

Total utility (TU): Total utility is the total satisfaction which a consumer derives from the consumption of a particular good over a period of time. For example, a person consumes five units of a commodity and derives  utility from the successive units of a good, his total utility will be,

Marginal Utility (MU): It can also be described as the extra satisfaction which a consumer gets from consuming additional unit of a good. More precisely, it is defined as the, addition to the total utility obtained from the consumption of one more unit. For example, the marginal utility of second glass of water is the change in total utility resulting from consuming the second glass of water.

Thus

Here Change in total utility and  change in Consuming an additional unit of a good. It can also be expressed as  here means total utility derived from the consumption of n units of a good and  is the total utility derived from the consumption of units.

It may here be noted that as a person consumes more and more units of a commodity, the marginal utility of the additional units begins to diminish but the total utility goes on increasing at a diminishing rate. When the marginal utility comes to zero or we say the point of satiety is reached, the total utility is the maximum. If consumption is increased further from this point of satiety, the marginal utility becomes negative and the total utility begins to diminish.

The relationship between total utility and marginal utility is now explained with the help of following schedule and a graph.

Schedule showing marginal utility and total utility

The above table shows that when a person consumes no apples, he gets no satisfaction. His total utility is zero, In case he consumes one apple a day, he gains seven utils of satisfaction. His total utility is 7 and his marginal utility is also 7. In case he consumes second apple, he gains an extra 4 utils (MU). Thus giving him a total utility of 11 utils from two apples. His marginal utility has gone down from 7 utils to 4 utils because he has a less craving for the second apple. Same is the case with the consumption of third apple. The marginal utility has now fallen to 2 utils while the total utility of three apples has increased to 13 utils (7 + 4 + 2). In case the consumer takes fifth apple, his marginal utility falls to zero utils and if he consumes sixth apple also, the marginal utility is reduced to negative (13 – 14 = –1). It is –1 utils. The table showing total utility and marginal utility is plotted in figure below:

(1)   The total.utility curve starts at the origin as zero consumption of apples yields zero utility.

(2)   The TU curve reaches at its maximum or a peak of M when MU is zero.

(3)   The MU curve falls throughout the graph. A special point occurs when the consumer consumes fifth apple. He gains no marginal utility from it. After this point, marginal utility becomes negative.

(4)   The MU curve can be derived from the total utility curve. It is the slope of the line joining two adjacent quantities on the curve. For example, the marginal utility of the third apple is the slope of line joining points a and b. The slope of such a line is given by the formula . Here .