Economics

Law of Diminishing Marginal Utility (DMU): Concept, Assumptions, Limitations, Importance and Exceptions

Before understanding what is Diminishing Marginal Utility? Let’s know what exactly is utility. The utility can be defined as the power of commodity or services which satisfies human needs. It is a psychological feeling when a consumer consumes a commodity, and they get some benefits in the form of satisfaction which is referred to as a utility.


Law of DMU: State the Law of Diminishing Marginal Utility With Example

German Economist Hermann Heinrich Gossen first developed the Law of Diminishing Marginal Utility in 1854. This law is also known as the first law of Gossen, and later on, it was promoted by Alfred Marshall.

According to the Law of Diminishing Marginal Utility can be defined as the consumer consuming more and units of matching commodity where utility obtained from that commodity decreases but the total utility of the increase in decreasing rate.

In 1854, Gossen explained this law after Alfred Marshall in the following words, “Other things remaining same, marginal utility becomes smaller and smaller as the more units of a commodity a person has.”

What is the Law of Diminishing Marginal Utility?

Diminishing Marginal Utility refers to the phenomenon that each additional unit of gain leads to an ever-smaller increase in subjective value. For example, three bites of candy are better than two bites, but the twentieth bite does not add much to the experience beyond the nineteenth (and could even make it worse). This effect is so well established that it is referred to as the “law of diminishing marginal utility” in economics (Gossen, 1854/1983), and is reflected in the convex shape of most subjective utility functions.

Law of Diminishing Marginal Utility Definition

According to the British economist Alfred Marshall, “The Law of Diminishing Marginal Utility is defined as the additional utility which a person derives from an increase of his stock of a commodity diminishes with every increase in the stock that he or she already has.”

The Law of Diminishing Marginal Utility states that the additional level of satisfaction diminishes with every increase in consumption units within the same time. Thus, when a consumer consumes more and more units of the same commodity, the successive level of utility diminishes.


Assumptions of Law of Diminishing Marginal Utility

Following are the assumptions of the Law of Diminishing Marginal Utility (DMU):

  1. Consumers should be rational.
  2. Cardinal measurement of utility.
  3. Constant marginal utility of money.
  4. Homogenous units of goods.
  5. No change in task and preferences of the consumer.

1. The Consumer Should Be Rational

The consumer is regarded as the rational person who aims to maximize their satisfaction with the perfect knowledge required to satisfy the constraints imposed by their income and commodities.

2. Cardinal Measurement of Utility

The consumption utility of any commodity can be measured. It is assumed that satisfaction can be measured in the same way that the natural consumption units can be calculated.

3. Constant Marginal Utility of Money

This theory assumes utility can be measured in terms of cordial number. The basis of measurement of utility is money. Money is the measuring rod of utility. Being a measuring rod of utility, the marginal utility of money remains constant throughout consumption.

4. Homogeneous Units of Goods

The units of goods consumed by the consumer must be identical in size, i.e. homogeneous and same quality. Otherwise, the law will not apply.

5. No Change in Task and Preferences of the Consumer

It is required that the preference of the consumer do not change. Only then we can assume that the marginal utility declines as consumption increases.


Explain the Law of Diminishing Marginal Utility With Diagram?

The Law of Diminishing Marginal Utility can be explained using a numerical table and geometrically with a diagram which is given below:

Law of Diminishing Marginal Utility Example

Units of Goods ‘X’ Total Utility Marginal Utility
0 0 10
1 10 8
2 18 6
3 24 4
4 28 2
5 30 0
6 30 -2
7 20 -4

The given table shows that a consumer consumes goods. The additional utility or marginal utility that the consumer obtains by consuming each successive unit of ‘X’ goods decreases until it goes down to zero at the 6th unit. It becomes negative with the 7th unit. The total utility increases until the consumption of the 5th unit, and in the 6th unit, the total utility stays constant but decreases in the 7th unit. The total utility increases at a diminishing rate. It is due to the diminishing marginal utility that the total utility increases at a decreasing rate.

Law of Diminishing Marginal Utility Diagram

Explain the Law of Diminishing Marginal Utility With Diagram

Law of Diminishing Marginal Utility Diagram

In the figure, MUx is the marginal utility curve derived based on individual consumption of successive units of good ‘X’. MUx is a downward sloping curve, meaning successive goods’ X’ decline below the X-axis, indicating negative utility.

When the marginal utility is positive, the total utility increases at a decreasing rate by an upward-sloping portion of the total utility curve TUx. Total utility is maximum where the marginal utility is zero. At the 6th unit, marginal utility becomes zero with the state of maximum satisfaction, and the total utility of the 6th unit is 30. When marginal utility becomes negative, the total utility curve starts to fall by the downward-sloping portion of the TUx curve.


Limitations of Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility is based on certain assumptions. Most of the time, these assumptions are applicable. The law is not practical in the case of the following situations:

  1. Irrational consumers
  2. Cardinal utility cannot be measured in number
  3. Indivisible commodity
  4. It doesn’t apply to the basic goods
  5. It does not apply to the goods of entertainment

1. Irrational Consumers

This law assumes that a consumer is a rational person. But, in reality, most people are irrational because they use their income without thinking.

2. Cardinal Utility Cannot Be Measured in Number

This law is based on upon cardinal utility approach, which differs from person to person & it is not possible to measure it in exact numbers.

3. Indivisible Commodity

This theory is applied only for divisible goods. But in real life, so many indivisible goods are divided into small units they loos utility.

4. Doesn’t Apply To The Basic Goods

The law of diminishing marginal utility fails even if essential goods such as food, clothes, air, etc., don’t decrease from their additional consumption unit.

5. Does Not Apply To The Goods of Entertainment

This law doesn’t apply to entertainment goods like CDs, TU, DVDs, etc., because such goods provide more satisfaction to the consumers.


Importance of Law of Diminishing Marginal Utility

Following are some of the importance of the Law of Diminishing Marginal Utility:

  1. Guidelines for taxation
  2. Basic for price determination
  3. Guidelines for the distribution of national wealth
  4. The basis for various laws in economics
  5. The basis for consumer expenditure

1. Guidelines For Taxation

It guides the finance minister while formulating the tax policy. A progressive tax policy, high tax for high-income people and low tax for low-income people, is based upon the marginal utility theory.

2. Basic For Price Determination

When a marginal utility is at least equal to its price, consumers desire to purchase the goods. Therefore, the consumer will pay a higher fee for those having higher MU and vice-versa.

3. Guidelines For The Distribution of National Wealth

The distribution of wealth and national income should be done as per the guidelines of MU theory. Since the demand of rich people beyond particular has a diminishing utility, whereas if the government distribute the wealth to the poor, it has a higher marginal utility.

4. The Basis For Various Laws in Economics

Various laws in economics are based on a law of diminishing marginal utility. For example, the law of demand, the law of substitution etc. These laws are derived from the direction of diminishing marginal utility.

5. The Basis For Consumer Expenditure

This law is essential to regulate the expenditure of the consumers. The consumer has a limited amount of budget with them. So, they do not waste their budget by purchasing more qualities. They stop their further purchase at a point where MU is equal to price.


Exceptions of Law of Diminishing Marginal Utility

Following are the exceptions of the law of diminishing marginal utility:

  1. The law is not applicable to good poetry and good song
  2. To a wine taker (drunkard) the utility of an additional cup of wine increases
  3. The law is not applicable if the units of a commodity are too small
  4. Lust for money and desire for display never reaches the point of satiety
  5. Collection of rare and curious commodities
  6. Greed increases with every additional acquisition of money
  7. Presence of supplementary goods
  8. Student’s reading books

1. The Law is not applicable to good poetry and good song

In the case of good poetry and good music, it has been experienced that a repeat hearing gives better satisfaction than the first one. Hence, the Law of Diminishing Marginal Utility may not be applicable here. But, we can say that there is a limit to it, as several repeated hearings of the same music or poetry prove to be monotonous and ultimately yields dis-unity; who does not know the effect of “too much of a good performance”? So it can be said that it is not a real exception to the law.

2. To a drunkard, the utility of an additional cup of wine increases

It is the view of the people that this law seems to be inapplicable to a drunkard as the intoxication increases with every successive dose of liquor. This is true, but the rationality condition of the law is violated. The behaviour of a drunkard in a drunken state is irrational or abnormal.

3. The law is not applicable if the units of a commodity are too small

In the case of minimal units, the Marginal Utility will increase instead of decrease; but ultimately, the Marginal Utility will fall if the consumption is continued. For example, if a person is given a spoonful of water when thirsty, each next spoonful will provide more satisfaction. But if the unit is the usual tumbler of water, the law starts working at once.

4. Lust for money and desire for display never reaches the point of satiety

It has been assumed that the Marginal Utility of money does not diminish as one never gets satisfied even though one gets more and more of it. But this is not a real exception because of the following reasons:

  • Money does not satisfy a want directly,
  • Money implies only purchasing power. Goods purchased with money have diminishing utility,
  • The marginal utility of money itself diminishes though very gradually and slowly.

Though it never becomes zero, it diminishes. This can be seen from this fact that the utility of a hundred rupee note to a millionaire is far less than its utility to the person who draws a salary of rupees one thousand per month.

5. Collection of rare and curious commodities

It is often argued that in certain hobbies like stamp collection, collection of antiques, collection of old coins etc., every additional unit gives more pleasure, i.e., the Marginal Utility tends to increase. This does not doubt a true statement, but it is not a real exception to the Law of Diminishing Utility because in such cases, the homogeneity condition of the law is violated. Indeed, each time, a new variety of stamps, coins, or antiques is collected by a person but not of the same type.

6. Greed increases with every additional acquisition of money

In the case of a miser, it has been pointed out that greed increases with every additional acquisition of money. Hence, the Marginal Utility of money does not diminish for him with more and more money. But here, we may say that when the miser spends his money, his utility of the commodity will be diminishing perhaps more rapidly than in the case of others. Hence, a miser’s behaviour cannot be a significant exception to the diminishing Marginal Utility.

7. Presence of supplementary goods

If supplementary goods are available, this rule will not apply because the utility of additional goods increases. For example, The utility of lanterns increases by the proper supply of kerosene oil. But this has not been accepted as a correct exception because the law operates in only one good.

8. Student’s reading books

Since more reading gives more knowledge, a scholar would get more and more satisfaction from every additional book. But here, it can be said that it is not a real exception to the law as the homogeneity condition is violated—knowledge and satisfaction increase by reading different books and not the same one, over and over again.

In the end, it can be said that “The Law of Diminishing Marginal Utility is true with no real exception”. In this connection, Prof. Taussig has said— “the tendency of Diminishing Marginal Utility operates so widely and with so few exceptions that there is no significant inaccuracy in speaking of it as universal.”

Prof. Clark thinks that the Law of Diminishing Marginal Utility is one of those universal principles which govern the economic life in all stages of development.” Therefore, the above analysis conclusion may be drawn that the exceptions to the Law of Diminishing Marginal Utility are only apparent and not actual. Hence, it can be said that the law is universally applicable.

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