LAW OF DIMINISHING MARGINAL UTILITY

The law of diminishing marginal utility is based on the following consideration or assumption:

“As the amount of a commodity a person possesses or consumes increases, the utility a consumer derives from successive units declines until marginal utility becomes zero and assumes negative value”.

The law illustrates the declining nature of marginal utility (MU). It stresses (states) that the amount of satisfaction derivable from successive units consumed declines continuously until marginal utility becomes zero and starts having negative figures (values).

At the initial stage of consumption of commodity total utility (TU) increases. And as a person consumes more of a commodity, the satisfaction he derives from successive (additional) units declines until TU reaches the point of satiety (maximum point) and thereafter it starts to decline (reduce).

When total utility is increasing. marginal utility is declining; and when total utility is at satiety point, marginal utility is at zero. As total utility declines marginal utility starts having negative value. And this continues until total utility becomes zero and both total utility and marginal utility assume negative values.

For instance, a thirsty man will be willing to pay a very high price such as N8.00 for a bottle of ice water for the first time as the utility he will derive from it is quite high. As he possesses more and more of the commodity, the marginal utility (i. e its value) diminishes until it eventually becomes zero; and he is no more willing to take additional bottle even though it is free The above explanation is clarified with a means of a utility schedule – table 2.

cropped1705072653819061411

 

From the foregoing discussion and the utility schedule, we wish to state that:

“the higher the quantity of a commodity a person consumes, the less the value he attaches to an additional unit. Conversely, the less the quantity of a product a consumer possesses, the higher the value he attaches to an extra unit”.

The consumer should stop at the sixth bottle where he attains ‘utility maximization – the point of satiety. The seventh bottle doesn’t add anything to the level or amount of satisfaction as the marginal utility is negative. Thus the major determinant of people’s desire for a commodity is the marginal utility and not total utility.

The law of diminishing marginal utility can also be demonstrated with the aid of a table or schedule and a graph below.

cropped674878182122968882

cropped2376234324876620857

 

Criticism of the Law of Diminishing Marginal Utility

The law of diminishing marginal utility has been largely criticised on the basis of its assumptions. Most of the assumptions are not realistic.

  1. The assumption that all commodities are divisible into small units is unrealistic. Houses, cars, etc. are in large forms and cannot be divided into small units. So their supply cannot be in small units but in whole units.
  2. Due to the influence of habit and impulse, people do not always weigh the marginal utility of commodities before purchasing them. So, the assumption that people must weigh the marginal utility to be derived from any commodity before purchasing it is not true.
  3. The law of diminishing marginal utility does not start operating as soon as consumption is increased. Before the point of origin is reached, marginal utility has increased.
  4. It is not always true that marginal utility decreases with increased consumption of a commodity. Certain commodities, when consumed, will lead to a corresponding increase in their demand, e.g. money, precious stones, jewelry etc.

 

Application

The Law of diminishing marginal utility (LDMU) can be used to explain the derivation of the demand curve as illustrated below.

Derivation of demand curve from utility function

A wise consumer buys a commodity if he feels that the satisfaction he will derive from it is either more or equal to its price. As he buys and consumes more units of the commodity, the marginal utility declines. This implies that he will only buy more if the price falls, as the price must be equal to the MU. Thus, as the price falls, the quantity he buys rises: ‘the lower the price, the higher the quantity demanded and bought’.

On the other hand, if the price starts to rise, he will not be willing to buy more because the satisfaction he will derive form additional unit well be less than the price. Thus ‘the higher the price, the less the quantity demanded’.

Firstly, from table 3, he pays N50 for one bottle of beer which he feels that is equal to 50 utils of satisfaction he will derive from its consumption. As he is a bit satisfied, he will only buy additional bottle if the price falls as the satisfaction he will derive from it will not be the same as the previous one. Thus he pays N45 for the second bottle which gives him 45 utils of satisfaction.

As the level of marginal utility falls, he pays less for additional unit (bottle). Thus he pays N35 for the third beer bottle. This clearly indicates that the lower the price, the higher the quantity demanded, and vice versa. The line that join the points slopes downward from left to right as clearly shown in figure 5. This indicates that the lower the price, the higher the quantity demanded and bought.

On the other hand, if the price starts to rise, he will not be willing to buy more because the satisfaction he will derive form additional unit will be less than the price. Thus ‘the higher the price, the less the quantity demanded’.

 

Summary

Marginal utility (MU) declines with successive units consumed. As the price of a unit must be equal to the marginal utility (level of satisfaction), its monetary value (price) also decreases as the marginal utility decreases.

The marginal utility and price fall as long as quantity demanded and consumed rise. In other words, the higher the quantity demanded and consumed, the lower the marginal utility and the price, Thus the demand curve which relates the price to the quantity demanded slopes downwards from left to right as illustrated in figures 5 below.

cropped7304686656094516971

 

cropped8642774507220678912

We plot “MU/price” on the vertical axis because nowadays marginal utility (MU) and price are the same as marginal utility (MU) is measured in monetary unit.

 

Consumer’s Surplus

The consumer’s surplus refers to the difference between the amount a consumer budgeted to pay for a particular commodity based on the expected level of satisfaction and the actual amount he paid to have the commodity. The concept of consumer’s surplus is represented in a graph shown in fig. 19.6.

cropped7461405127545589423

 

From the above graph, it is observed that when the consumer made use of the very first unit, he was willing to pay as much as N120.00 but the commodity price was N50.00. So, he was able to save about N70.00. Therefore, any amount above the market price of N50.00 represents the consumer’s surplus.

 

Theory of consumer behaviour is based on the following assumptions:-

  1. He behaves rationally (wisely).
  2. His taste remains constant.
  3. He has a budget constraint.
  4. He aims at maximizing his utility.
  5. He is exposed to more than one good and service.

 

Conditions for utility maximization

A consumer maximizes his utility if he allocates his money among the commodities he consumes in such away that the utility he derives from one Naira he spends on each commodity gives him equal satisfaction. Briefly, utility is maximized if:

  1. Marginal utility of a naira spent on a commodity is equal to marginal utility of a naira spent on other commodities.
  2. The ratio of marginal utilizes of the commodities (A & B) he consumes is equal to the ratio of their prices. Mathematically, this is expressed as follows:-

cropped5457514433261511890

 

The above is a situation in which he consumes only two commodities.

If a consumer consumes only one commodity, he maximizes his utility if his marginal utility (MU) of the commodity (A) is equal to its price. Its mathematical expression is as follows:

MUa = Pa

Thirdly, if a price of one commodity (X) is twice the price of another commodity (Y), utility is maximised if marginal utility of commodity X is also twice the marginal utility of commodity Y. Its mathematical expression is as follows:-

2MUx = 2Px

MUY = Py

Fourthly, if all commodities are free, he maximizes his utility if he consumes them up to the point where their marginal utilities are zero.

Leave a Reply

Your email address will not be published. Required fields are marked *