In making choices, most people spend their incomes over different kinds of goods. people prefer a variety of goods and services because consuming more and more of the same thing reduces the marginal satisfaction derived from its further consumption. This phenomenon is explained by the Law of Diminishing Marginal Utility.
Law of Diminishing Marginal Utility
The law of diminishing marginal utility expresses an important relationship between utility and the quantity of a commodity consumed. Law of Diminishing Marginal Utility states that as we consume more and more units of a commodity, the utility derived from each successive unit goes on decreasing. Let us consider an example.
Suppose you have come home from outside and are very thirsty, and your mother offers you a glass of juice. The first glass of juice will give you great satisfaction. The satisfaction with the second glass of juice will be relatively lesser. With constant consumption, a stage will come when you would not need any more juice, this means that marginal utility has reached zero. After this point, if you are forced to consume more juice, it will lead to disutility. Such a decrease in satisfaction with consumption of successive units occurs due to law of diminishing marginal utility.
In other words, it says that as more and more units of a commodity are consumed, the marginal utility (MU) will keep on diminishing, will reach zero and continue to become negative. This can be seen in the diagram given below,
The law of diminishing marginal utility has universal application, i.e. it applies to all goods and services. This law was given by H.H. Gossen, which is why it is also known as ‘Gossen’s first law of consumption’. It is also known as the ‘Fundamental Law of Satisfaction’ or ‘Fundamental Psychological Law.
It must also be noted that although the Law of diminishing marginal utility says that MU decreases, it does not say anything about the rate at which the MU decreases or whether it is uniform or variable. It is also important that each unit of the commodity consumed is of the same quantity and the amount does not vary with repeated consumption.
Assumptions of the Law of Diminishing Marginal Utility
- Cardinal measurement of utility is used.
- It is assumed that utility is measured in monetary terms.
- It is assumed that a reasonable quantity is consumed.
- The consumption is assumed to be continuous.
- The quality of the commodity consumed does not change.
- The consumer is assumed to be rational.
- The MU of one commodity has no relation to the MU of another commodity.
- MU of money remains constant. As the consumer spends more on commodities, money becomes dearer to him ad he tries to spend less which increases the MU of money. In this case, MU of money has to be constant to measure the MU of the commodity.
- The prices of the commodities and the income of the consumer are assumed to be fixed.
- It is assumed that the consumer has perfect knowledge of the various choices available to him.