What is Law of diminishing marginal utility?
In economics, utility is the satisfaction you get by consuming a product. On the other hand, marginal utility is the additional utility you get when you consume an extra unit of the product. Though human needs are unlimited, everyone’s wants are satiable. Because of this, the more we consume a product, the less we desire to have it. This concept is what economists refer to as the law of diminishing marginal utility. According to this law, as the amount of a commodity one consumes goes up, the utility the consumer derives from an additional unit of the same commodity goes down.
This law offers a wide range of explanations to economic phenomena like time preference and valuation of goods in the market. It also offers explanation to the fact that capitalism is superior to socialism in economical and ethical aspects. Developed by Carl Menger (1840–1921), the law remains axiomatic in nature, meaning that it is irrefutably true. However, in mainstream economics, the law is thought to rest on psychology, i.e. the satiation law of wants.
Applications of the law of diminishing marginal utility
The law of diminishing marginal utility has a wide range of applications in the world today. In this section, we shall look at three scenarios. Firstly, the law is applied in the rising of money stock. A rise in the money stock always leads to a drop in the exchange value of a money unit. This is because the additional money could meet an additional need that is less urgent and important as compared to the preceding need. Thus, a rise in money stock would lead to a reduction in the marginal utility of an extra money unit.
Economists also apply this law in lowering of market interest rates. A pure market interest rate always shows societal time preferences. This finds application in the axiom of human action. Time axiom preference implies that market agents place a higher value of goods that are present on the market than those to come.
Lastly, the law is applied in the violation of a person’s property rights. Such violations could be through government taxation and restrictions. In such event, property owners will value present goods increasingly higher than future goods. This conclusion follows from the law of diminishing marginal utility.
Negative marginal utility and exception of the law
Even though there are cases where will be marginal utility to produce or consume a commodity, marginal utility can be negative. A good example of this is the use of antibiotics in curing illnesses. While antibiotics remain effective in treating diseases overdosing yourself can lead to other complications or resistance, making it impossible to cure the infection in future. This means that under this law, ‘diminishing’ does not always mean dropping to zero. It could imply having too much of something good.
Besides negative utility, there are exceptional cases where this law does not apply. For instance, there could be cases where one derives more utility from future goods or services than what they get by consuming current goods. This occurs when what you are consuming is a component of something large. However, marginal utility only increases up to the tipping point.
Benefits of the law of diminishing marginal utility
The law of diminishing marginal utility has great significance in the world of economics. If offers practical and theoretical significance. Here are some of the benefits. Firstly, it is the basic law of economics, from which other laws originate. It is the foundation of the laws of consumption and the pillar of the law of demand. For example, in demand, consumers purchase larger quantities of a commodity at lower prices. This is because as a buyer purchases more units of the same commodity, its marginal unity decreases. Therefore, he pays lesser value to additional units and is only ready to purchase at a lower price.
The law also offers better insights into the paradox of value. Obviously, the value in use of a commodity is different from the value in exchange. For example, diamond has high value in exchange since they are scarce and with great marginal utility. On the other hand, water has a lower marginal utility because of its abundance. Thus, it has no price tag despite its high total utility.
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References:
http://hubpages.com/education/Advantages-of-the-Law-of-Diminishing-Marginal-Utility
http://smallbusiness.chron.com/relationship-between-law-diminishing-marginal-utility-consumer-surplus-67182.html
https://mises.org/library/what-can-law-diminishing-marginal-utility-teach-us
https://www.boundless.com/economics/textbooks/boundless-economics-textbook/consumer-choice-and-utility-5/the-demand-curve-and-utility-52/principle-of-diminishing-marginal-utility-200-12295/