Law of Diminishing Utility Homework Help

Description of  Law of Diminishing Utility:

It is the fundamental law of utility analysis.

“The additional benefit which a person derives from a given increase in the stock of a thing diminishes with every increase in the stock that he already has” as stated by Alfred Marshall

Law of Diminishing utility

What is utility:

It is the power of a commodity or service to satisfy a want or a desire.The utility is the level of happiness or satisfaction which a consumer gets when he consumes a product. It is a subjective concept.

Cardinal and ordinal approaches:

Cardinal Approach says the utility is measurable or quantifiable indefinite numbers. The unit of measurement is utils. An example is Diminishing Marginal Utility.

Ordinal approach says the utility is a psychological phenomenon and hence cannot be measured. It can be only ranked or ordered according to preference. An example is Indifference curve analysis.

Total and marginal utility:

Total utility is the total level of satisfaction derived from consuming the good.

Marginal utility is the additional satisfaction that is received when an additional unit of a good is consumed.

Assumptions of the law:

The utility can be measured in cardinal numbers. Every unit of the commodity consumed should be homogeneous or identical in all respects. There is a continuous consumption of the commodity.

An example is a cup of tea in the morning and another in the evening may not be subject to the law of DMU.

Marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus. Even though marginal utility declines, the total utility still increases as long as marginal utility is positive. The total utility will decline only if marginal utility is negative.

Exceptions to the law:

Rare and curious things: They include the collection of more and more units of such things such as old coins, rare paintings, stamps etc gives more and more satisfaction to the collector.

Drunkards: A drunkard is said to obtain increasing utility from each additional peg of wine.

The paradox of value:

The law explains the paradox of value. The paradox of value is also known as diamond –water- paradox by Adam Smith.

As noted by Adam Smith, water is essential for life and has a low market price (often a price of zero) while diamonds are not as essential yet have a very high market price.

Reason - Diamond is a scarce commodity (and hence its MU is high) and water is found in abundance (and hence its MU is low). Thus the price of a commodity is determined by its marginal utility and not the total utility.

If it is a free commodity or service, the consumer will be in equilibrium if MU= 0.

If it is a commodity or service for which he needs to pay a price then the consumer will be in equilibrium if MU= P.

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