Introduction
The concept of utility lies at the heart of classical and neo-classical demand theory. In the cardinal utility approach, it is assumed that a consumer derives a certain amount of satisfaction (utility) from each unit of a commodity consumed, and that this utility can be expressed in numerical units called utils. As consumption of a commodity increases, the total utility (TU) obtained from all units together and the marginal utility (MU) obtained from an additional unit play a crucial role in determining the consumer’s demand behaviour.
The Law of Diminishing Marginal Utility (LDMU) is a fundamental psychological law of consumption which explains how marginal utility behaves as consumption increases. It lays the foundation for the law of demand and many other results in microeconomic analysis. Panjab University repeatedly examines this law not only in its formal statement but also in terms of its assumptions, diagram, justification, criticisms and practical importance.
Concept of Utility: Total Utility and Marginal Utility
Utility refers to the power or capacity of a commodity to satisfy human wants. It is a subjective concept and varies from person to person, place to place and time to time. In the cardinal approach:
- Total Utility (TU): The total satisfaction obtained from consuming all units of a commodity.
- Marginal Utility (MU): The additional satisfaction obtained from consuming one more unit of the commodity.
Symbolically, if TUn is total utility from n units and TUn-1 from n−1 units, then:
MUn = TUn − TUn−1
Statement of the Law of Diminishing Marginal Utility
According to Alfred Marshall, “The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has.”
In simple words, as a consumer consumes more and more units of a commodity, the marginal utility obtained from each successive unit tends to diminish, other things remaining the same.
Thus, while total utility may initially rise as consumption increases, the marginal utility (extra satisfaction from each additional unit) keeps on falling and ultimately becomes zero, and may even turn negative if consumption is carried beyond a certain point.
Assumptions of the Law
The law of diminishing marginal utility is based on certain important assumptions. Unless these conditions are broadly satisfied, the law may not hold in its simple form:
- Homogeneous Units: All units of the commodity consumed are assumed to be identical in every respect (size, quality, taste etc.). If the units differ in quality, the pattern of utility may not follow a neat diminishing pattern.
- Continuity of Consumption: The units are consumed in close succession without long time gaps. If there is a long interval between successive units, the consumer’s want may revive fully and MU may not diminish smoothly.
- Rational Behaviour: The consumer is assumed to be rational and aims at maximising his satisfaction. He arranges his consumption in order of preference and does not act impulsively or irrationally.
- Constancy of Tastes, Income and Habits: During the process of consuming successive units, the consumer’s tastes, income, habits and fashion are assumed to remain constant. Any change in these may disturb the utility schedule.
- Constancy of Prices of Related Goods: The prices of substitutes and complements are assumed to be constant. If the price of a substitute falls or of a complement rises, the consumer may change his pattern of consumption, affecting MU.
- Divisibility of the Commodity: The commodity is assumed to be divisible into small units so that consumption can be increased one unit at a time.
- Reasonable Range of Consumption: The law is presumed to operate within a sensible range of consumption. Extremely small or extremely large quantities may not behave in the standard diminishing fashion.
Illustration with Hypothetical Schedule
The law of diminishing marginal utility can be illustrated with the help of a simple numerical example. Consider a consumer who consumes glasses of water when thirsty. The following table shows how his total utility and marginal utility change as he increases consumption:
| Units of Water (per sitting) | Total Utility (TU) | Marginal Utility (MU) |
|---|---|---|
| 1 | 20 | 20 |
| 2 | 38 | 18 |
| 3 | 54 | 16 |
| 4 | 68 | 14 |
| 5 | 78 | 10 |
| 6 | 84 | 6 |
| 7 | 88 | 4 |
| 8 | 90 | 2 |
| 9 | 90 | 0 |
| 10 | 88 | -2 |
The table shows that as the consumer increases his consumption from 1st to 8th unit, total utility increases but at a diminishing rate. Marginal utility steadily falls from 20 to 2 and ultimately becomes zero at the 9th unit, where total utility is maximum (90 utils). If the consumer still consumes the 10th unit, marginal utility becomes negative (−2) and total utility starts declining. This negative MU indicates dissatisfaction, discomfort or disutility.
Diagrammatic Explanation
The behaviour of total and marginal utility can be shown diagrammatically. On the horizontal axis we measure the quantity of the commodity and on the vertical axis we measure utility in utils. The TU curve rises at a diminishing rate and then becomes horizontal at the maximum point where MU is zero. The MU curve slopes downwards from left to right and cuts the horizontal axis at the point where TU is maximum.
Economic and Psychological Explanation of the Law
The law of diminishing marginal utility is not arbitrary; it rests on sound psychological and economic reasons:
- Saturation of a Particular Want: Every single want has a limited intensity. As a consumer continues to consume more units of a commodity satisfying a particular want, he gradually approaches saturation. At the point of full satisfaction, the marginal utility of an additional unit becomes zero, and beyond that it becomes negative.
- Intense Wants are Satisfied First: Consumers allocate the first few units of a commodity to the most urgent or intense uses. Additional units are used to satisfy less urgent wants. Naturally, the satisfaction from these successive units is smaller.
- Indivisibility and Complementarity of Goods: Many commodities are used in combination with other goods. As consumption of one good rises without a proportionate rise in complementary goods, their additional usefulness decreases.
- Human Psychology of Variety: Human beings prefer variety in consumption. Repetition of consumption of the same commodity, unit after unit, reduces the intensity of satisfaction, thereby causing marginal utility to diminish.
- Limited Capacity: Physical and mental capacities of individuals are limited. For instance, there is a limit to how much one can eat or drink at a time. Once that limit is approached, extra units produce less and less satisfaction and may cause discomfort.
Critical Evaluation and Limitations of the Law
Although the law of diminishing marginal utility is widely accepted, it has been subjected to various criticisms:
- Cardinal Measurement of Utility is Unrealistic: The law presupposes that utility can be measured in cardinal numbers (1, 2, 3… utils). Modern economists argue that utility is essentially ordinal: a consumer can rank bundles but cannot assign precise numerical values.
- Over-Simplified Assumptions: Assumptions like complete homogeneity of units, continuous consumption, constant tastes and income etc. are often unrealistic. In real life, quality changes, fashion changes and time gaps exist.
- Neglect of Income and Substitution Effects: The law focuses only on marginal utility of a particular commodity and ignores how changes in its consumption affect the allocation of income among different commodities.
- Indivisible and Durable Goods: The law is more directly applicable to divisible, perishable goods like food items. For durable and indivisible goods (cars, machines, houses), the notion of successive “units” is more complex to apply.
- Exceptional Cases: In some apparent special cases such as rare collections, status goods or addiction, marginal utility may not seem to diminish in the usual way. However, in many of these cases, the “commodity” being enjoyed is not simply the physical good but the prestige or rarity associated with it.
- Indifference Curve Approach as an Alternative: Modern ordinal utility analysis based on indifference curves has largely replaced cardinal marginal utility analysis for rigorous theory. Nevertheless, the law of diminishing marginal utility remains a useful intuitive and pedagogical tool.
Importance and Applications of the Law of Diminishing Marginal Utility
Despite criticisms, the law of diminishing marginal utility has far-reaching theoretical and practical importance. Some of the key applications are as follows:
The law of demand, which states that quantity demanded increases when price falls (ceteris paribus), is fundamentally rooted in diminishing marginal utility. When price falls, it becomes worthwhile for the consumer to purchase additional units, whose marginal utilities are lower than the earlier units. He continues to buy more until the marginal utility of the last unit becomes equal to the new lower price. Thus, diminishing marginal utility combined with the condition of consumer equilibrium (MU = Price) yields a downward-sloping demand curve.
The law provides a strong justification for progressive taxation. As income increases, the marginal utility of income to a rich person diminishes; sacrificing one rupee at higher income levels causes less loss of satisfaction than sacrificing one rupee at lower income levels. Therefore, higher-income groups can be taxed at higher rates with relatively smaller sacrifice of welfare. This supports the equity argument for progressive tax systems.
In cardinal utility theory, a consumer reaches equilibrium when the marginal utility of each commodity divided by its price is equal across all goods and equals the marginal utility of money. Diminishing marginal utility is essential for this condition to hold and for a stable equilibrium to exist. Without diminishing MU, a consumer could not reach a balanced allocation of expenditure.
Consumers seldom spend their entire income on a single commodity. Due to diminishing marginal utility, they allocate income across a variety of goods to maximise total satisfaction. The law thus explains why consumption baskets are diversified and why “variety” plays such an important role in consumer choice.
Social reformers and welfare economists use the law to argue that a more equal distribution of income can increase total social welfare. Taking one unit of income from a very rich person (for whom marginal utility of income is low) and giving it to a poor person (for whom marginal utility of income is high) increases the sum total of utilities in society. Thus, the law supports redistributive and welfare policies.
Business firms often use the idea of diminishing marginal utility in designing pricing strategies, sales promotions and quantity discounts. For example, “buy one, get one at half price” or bulk discount schemes attempt to overcome falling marginal utility by reducing price on additional units so that MU remains at least equal to price.
In monopoly and imperfect competition, the marginal revenue curve slopes downwards because additional units can be sold only at lower prices. This, in turn, ultimately stems from the diminishing marginal utility of the product to consumers, which makes them unwilling to buy extra units at the same high price.
The law reminds individual consumers to avoid over-consumption of any one commodity. It suggests that consuming very large quantities of a single good when its marginal utility has become negligible or negative is irrational and wasteful. Instead, consumers should spread their expenditure across goods to keep marginal utilities reasonably high.
Critical Discussion: Balanced View
A critical discussion of the law of diminishing marginal utility must strike a balance between its limitations and its practical significance. On the one hand, its assumptions of cardinal measurability, continuity and constancy of tastes may not strictly hold in reality; on the other hand, its core message is strongly supported by everyday experience and continues to be used in intermediate-level economic reasoning.
Modern ordinal utility and indifference curve analysis no longer relies explicitly on numerical marginal utilities, yet the intuitive idea that additional units of a good yield progressively less satisfaction remains embedded in the rationale for a downward-sloping demand curve and for the concept of consumer equilibrium. Thus, the law retains both pedagogical and intuitive value in microeconomic theory.
Conclusion
In conclusion, the Law of Diminishing Marginal Utility is a cornerstone of classical demand theory. It explains how satisfaction behaves as consumption increases, provides the psychological foundation of the law of demand, supports progressive taxation and welfare economics, and clarifies the logic of diversified consumption and pricing strategies. Although some of its assumptions have been refined or replaced in modern analysis, the law remains an indispensable tool for understanding consumer behaviour and continues to occupy a central place in undergraduate microeconomics, especially in the framework developed by T.R. Jain and V.K. Ohri for B.Com Semester I.