Law of Diminishing Marginal Utility

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Law of Diminishing Marginal Utility?

The law of diminishing marginal utility states that the amount of satisfaction provided by the consumption of every additional unit of good decreases as we increase that good’s consumption. Marginal utility is the change in the utility derived from consuming another unit of a good.

Key Takeaways

  • The law of diminishing marginal utility refers to the quantity of satisfaction offered by each additional unit of good consumption decreases as we escalate the good’s utilization.
  • Marginal utility refers to the change in the utility obtained from using another good unit.
  • The assumptions of the law of diminishing marginal utility are rational consumers, continuous consumption, and standard size of units.
  • The exceptions of diminishing marginal utility are addictions/hobbies, rare items, and unrealistic assumptions.

Law of Diminishing Marginal Utility Graph

If we were to represent the law of diminishing marginal utility using a graph, it would look like the figure below. In this figure, the X-axis represents the number of units of a good consumed, and the Y-axis represents the marginal utility of that good. Notice that as we increase the number of units, the marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. It could be calculated by dividing the additional utility by the amount of additional units.read more of every additional unit falls. It keeps falling until it becomes zero and then further sinks to negative. After a certain point, consuming that good may cause dissatisfaction to the consumer.

examples of law of diminishing marginal utility

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Law of Diminishing Marginal Utility (wallstreetmojo.com)

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Examples of the Law of Diminishing Marginal Utility

Let us understand the concept first using some elementary examples of the law of diminishing marginal utility.

Example #1

Suppose a person is starving and has not eaten food all day. When he finally starts to eat, the first bite will give him a lot of satisfaction. As he keeps eating more and more food, his appetite will decrease and come to a point where he does not want to eat anymore.

Example #2

Suppose there is a manufacturer who has a huge demand for his products. To meet this demand, the manufacturer will employ more workforce. But eventually, there will come a point where hiring more workers does not benefit the organization. Instead, hiring more workers brings down the production per worker since the quantity demandedQuantity DemandedQuantity demanded is the quantity of a particular commodity at a particular price. It changes with change in price and does not rely on market equilibrium.read more was being met by fewer workers. This example illustrates the law of diminishing marginal utility because hiring additional workers will not benefit the organization after a certain point.

Assumptions of the Law of Diminishing Marginal Utility

  • Rational Consumers – It requires consumers to behave rationally. They should make sound decisions at all times. The law assumes that consumers try to maximize utility subject to their incomes.
  • Continuous Consumption – This assumption is fundamental for the law to hold. It means that the consumer continuously consumes every additional unit of the good. Therefore, there should not be intervals between the consumption of other units. For example, if a hungry person eats a pizza for lunch and then eats more pizza for dinner, the law is violated because the consumer is again hungry and derives increased utility from the second pizza than he would if he eats it right after lunch. So, intervals between the consumption of additional units violate the law.
  • Standard Size of Units – The size of every unit should be common. If a person drinks half of a glass of water, drinking another half glass after it might not diminish the utility since he has not yet derived the total utility from consuming a full unit of the good. Reducing the size of units consumed is not consistent with the law of diminishing marginal utility.

Exceptions of Diminishing Marginal Utility

  • Addictions/Hobbies – This law does not hold in the case of addictions. The marginal utility of having an additional glass of alcohol does not decrease for an alcoholic. Similarly, in the case of hobbies, a person who likes to paint might not experience diminishing marginal utility in making a new painting.
  • Rare Items – It also does not hold in the case of rare items. It is especially true for enthusiasts who chase such things and are passionate about them. For example, acquiring a limited-edition watch might give much more satisfaction to an enthusiast who likes collecting watches and already has many of them.
  • Unrealistic Assumptions – Assumptions made by this law do not always hold. A consumer might make an irrational decision; there could be intervals between the consumption of units of a good, etc. Violating these assumptions might cause the law to not hold for a certain situation.

Conclusion

The law of diminishing marginal utility is widely studied in Economics. It helps us understand why consumers are less satisfied with every additional goods unit. The law is based on the ordinal utility theory and requires certain assumptions to hold. However, there are exceptions to the law as it might not have the truth in some cases.

Frequently Asked Questions (FAQs)

What is the law of diminishing marginal utility importance?

The law of diminishing marginal utility is crucial in the economy. It is directly related to goods consumption and production. This law is essential as it also states that more consumption of commodities may result in less satisfaction.

What are the limitations of law of diminishing marginal utility?

The law of diminishing marginal utility has limitations like possessing smaller commodity units. If the commodities units are small, then the law would not work. It also has limitations if the commodities units are not similar. Therefore, it must be similar in size also.

What is the real life example of law of diminishing marginal utility?

A real-life example of the law of diminishing marginal utility is food. The more one eats the food; the less hungry one will be.

Who gave the law of diminishing marginal utility?

Alfred Marshall’s Principles of Economics gave the law of diminishing marginal utility. It is also found that Herman Gossen initially put out what is now known as the Law of Diminishing Marginal Utility in 1854, stating that “the magnitude of the same enjoyment, while we continue to enjoy it without interruption, continuously decreases till fulfillment is obtained.”

This article is a guide to the Law of Diminishing Marginal Utility. We discussed the exceptions of the law of diminishing marginal utility with examples, assumptions, and graphical representation. You can learn more about it from the following articles: –

Reader Interactions

Comments

  1. Azeez Ayomide says

    Of course I did understood all of these

  2. Sophia David says

    Really understood

Leave a Reply

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