Law of diminishing marginaL utility when a good is free:
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.
|
Units |
Total Utility |
Marginal Utility |
|
1st glass |
20 |
20 |
|
2nd glass |
32 |
12 |
|
3rd 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 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 5th glass of water is zero. It is called the satiety point. The MU of the 6th 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:
- 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.
- 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.
- 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.
- 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.
- 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 2nd at noon, the marginal utility of the 2nd glass of water may increase.
- 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.
- 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.
- 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.
- 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 2nd 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.
- 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.
- 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.
- 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.
- 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.
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