Unit- 1 Diminishing Marginal Utility POE | BBA First Year

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Definition Diminishing Marginal Utility

• The Law of Diminishing Marginal Utility states that all else equal as consumption increases the marginal utility derived from each additional unit declines.  Marginal utility is the incremental increase in utility that results from consumption of one additional unit.
• Marginal utility may decrease into negative utility, as it may become entirely unfavorable to consume another unit of any product. Therefore, the first unit of consumption for any product is typically highest, with every unit of consumption to follow holding less and less utility. Consumers handle the law of diminishing marginal utility by consuming numerous quantities of numerous goods.
  

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Example of Diminishing Marginal Utility

• An individual can purchase a slice of pizza for $2; she is quite hungry and decides to buy five slices of pizza. After doing so, the individual consumes the first slice of pizza and gains a certain positive utility from eating the food. Because the individual was hungry and this is the first food she consumed, the first slice of pizza has a high benefit. Upon consuming the second slice of pizza, the individual’s appetite is becoming satisfied. She wasn’t as hungry as before, so the second slice of pizza had a smaller benefit and enjoyment as the first. The third slice, as before, holds even less utility as the individual is now not hungry anymore.
•  The individual is so full from the first four slices that consuming the last slice of pizza results in negative utility. In a business application, a company may benefit from having three accountants on its staff.

This law can be stated thus:

• “The more one consumes of one commodity during any period of time the less satisfaction one gets from consuming an additional unit of it”
• As one adds to his (her) weekly consumption of chocolate, each additional unit adds to his TU or total satisfaction, but each unit adds less utility than the one before it.
• Utility schedule presented in Table 4.1 can be represented diagrammatically. See Fig. 4.1. In Fig. 4.1 our representative consumer Mr. John is seen to add to his total satisfaction as he increases weekly purchase of chocolate until he is buying 5 units (bars) per day. A 6th bar per week gives him disutility or dissatis- faction.
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• 4.2 (which is derived from Fig. 4.1) illustrates the Law of Diminishing MU. This indicates that the additions to TU of chocolate became less as more bars per day are purchased. It is clear that the MU of the six bars per day is negative, i.e., the sixth bar causes a decrease in TU.

Assumptions of the Law

• The Law of Diminishing Marginal Utility is based on the assumptions:

1. The maximum price a consumer is ready to pay for the commodity depends on its marginal utility to him.
2. The taste and preference of the consumer remain unchanged during the period of purchases.
3. The initial amount of consumption is sufficient to give the consumer full satisfaction.

Causes of Diminishing Marginal Utility:

• Three important causes of the diminishing marginal utility are:

1. Satisfaction of a Particular Want

• As a person consumes more and more of a commodity, his indication becomes less and less. So his marginal utility from the successive units becomes gradually smaller. It means that too many units of a commodity bring complete satisfaction.

2. Introspection

•  The classical economists used to look into their minds for their own psychological reaction to the extra consumption of a particular thing (say, an apple, an ice-cream, a chocolate, etc.) and tested the truth of the law.

3. Less Important Uses of Additional Quantities

• Furthermore, marginal utility diminishes because a person, having several units of a commodity capable of alternative uses, puts one unit to its most important use and the additional units to the successively less important uses.

Limitations of the Law

• The Law may not operate in certain circumstances and in those exceptional cases the marginal utility of a thing may increase for some time.
• Six important exceptional cases to the law are:

Change of Taste and Preferences

• If a consumer’s taste changes so that he likes a commodity more, the marginal utility of any quantity of that commodity rises. A person may not have initially any interest in eating egg roll. But after taking one egg roll, he may form a good taste for it and may get a great satisfaction from the 2nd or the 3rd one.

Inadequate Initial Consumption

• If a person consumes a very small quantity of a particular thing at the initial stage, he may not get full satisfaction from it. In such a case his satisfaction will be greater from the second unit. Thus, coke in a small glass may not quench one’s thirst at all, as such, the satisfaction from the second one is likely to be greater.

Emotional or Fancy Buying

• The marginal utility of a thing does not diminish when a buyer purchases it in a larger quantity out of sheer emotion or fancy. An example is the art work of a known painter or a rare book of a dead author.

Miser’s Collections Hobby

• A miser gets a greater satisfaction from the additional collection of money. Similarly, a person gets more and more satisfaction as his hobby-collections (e.g., stamps, coins, works of art, etc.) increase gradually.

Consumption at

• Different Time Periods If a person consumes different units of a particular thing at different times, the marginal utility from the successive units is not likely to be smaller. Thus, if he consumes the 1st ice-cream in the morning, the 2nd in the afternoon and the 3rd at night, the marginal utility may not diminish.

Stock with Other Persons

• Sometimes the utility of a thing depends on its stock with the others. If in a locality all but one have two cars, the second car to that man will not yield diminishing utility.