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Utility. The law of diminishing utility.

 

Economists use the word utility to describe the ability of a good or service to satisfy some want we possess. Economists sometimes speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a good or service gives more utility than the second and subsequent units. The marginal decision rule states that a good or service should be consumed at a quantity at which the marginal utility is equal to the marginal cost.

Each economic good has a total utility and marginal utility.

If we could measure utility, total utility would be the number of units of utility that a consumer gains from consuming a given quantity of a good, service, or activity during a particular time period. The higher a consumer’s total utility, the greater that consumer’s level of satisfaction. With a growing number benefits available to the consumer, increasing total utility, but the rate of increase slows down.

TU = ƒ(Q)

Horizontal axis is the number of good, vertical - total utility goods. Max shows a peak point of saturation needs.

Graph shows the total utility, while at first total utility goods rises, after a point max it decreases.

Thus, the more benefits the consumer has, the less value it has for each additional unit of that good.

Change in total utility is reflected in indicator of marginal utility.

Marginal utility - the amount by which total utility rises with consumption of an additional unit of a good, service, or activity, all other things unchanged.

MU = TU_i+1 - TU_i

At point Q₄ the value of TU reaches its maximum and the value of MU – zero.

The law of diminishing marginal utility - a law that reflects the relationship between the amount of goods consumed and the degree of satisfaction from consuming each additional unit.

The law of diminishing marginal utility expresses the universal human experience. This law was at first pointed out by H.H Gossen. So this law is known as Gossen’s First law. This law was developed by W.S. Jevons in England and by Kari Menger in Austria about the same time (1871) and modified by Alfred Marshall. This law states that if a person consumes more and more units of a commodity, its marginal utility declines. In other words, larger the stock possessed by a person, the smaller the utility he derives from an additional unit of the commodity.

According to Marshall – “The additional benefit which a person derives from a given increases of his stock of anything diminishes with the growth of the stock that he has”.

In other words of K.E. Boulding – “as a consumer increases the consumption of any one commodity, keeping constant the consumption of all other commodities, the marginal utility of the variable commodity must eventually decline”.

The law can be express in another way as well. As opined by Watson and Getz –“The more you have of anything, the less important to you is any one unit of it”. So when a consumer gets more and more unit of commodity he puts it to less and less urgent uses. We can illustrate it by the help of W.J. Baumol’s interesting example. If a man has a cake, he gives it to his child. If he has two cakes, he gives the second cake to his wife. If he has three cakes, he keeps the third one for himself and if he has four cakes he gives the fourth one to his brother-in-law. This clearly indicates the declines in marginal utility of cake. Свой пример

Different concepts of utility underlie different theories in which marginal utility plays a role. Economists have commonly described utility as if it were quantifiable, that is, as if different levels of utility could be compared along a numerical scale.^[3][4] This has affected the development and reception of theories of marginal utility. Quantitative concepts of utility allow familiar arithmetic operations, and further assumptions of continuity and differentiability greatly increase tractability.

Contemporary mainstream economic theory frequently defers metaphysical questions, and merely notes or assumes that preference structures conforming to certain rules can be usefully proxied by associating goods, services, or their uses with quantities, and defines "utility" as such a quantification.

There are several reasons for the decrease in marginal utility. They are:

(a)    Physiological and Psychological 

 

The consumption or possession of too many units of commodity brings physical satiation. The response to a repeated stimulus diminishes. 

 

(b)   Possibility of Having Everything  

 

If a consumer could have everything he wants free of cost, he could choose those quantities of each good that would make the marginal utility of each one zero. This implies that he would maximize total utility for each good. Marginal utility, therefore, would have to diminish to get to zero. 

 

(c)    Several Uses of Commodity 

 

Each commodity may have several uses. Each consumer ranks the uses, if the consumer has one unit of a commodity; he puts it to most important use. If he has more units, he puts them to less and less important uses. Marginal utility diminishes, because of the successively less important uses of additional quantities of commodity.

Importance of the Diminishing Utility

The law of diminishing utility has both theoretical and practical importance as follows: 

 

1.       Basic of Other Laws 

 

Some of the laws of economics and law of consumption are based on this law. As for example, the law of demand, law of maximum satisfaction, and law of consumer’s surplus is based on this law. 

 

2.       Theory of Taxation 

 

This law also serves as the basis of theory of taxation. The more tax is imposed on the rich while less tax is imposed on the poor. Because, the utility of money is less to the rich and more to the poor. 

 

3.       Advocacy of Equal Distribution of Income and Wealth 

 

People advocate equal distribution of income and wealth among the people of the country. Because the poor people get more utility from money whereas the rich people get less utility from money. 

 

4.       Determination of Market Price 

 

This law is also useful in determination of market price. The increase in stock of a commodity gives less utility. Hence, the people can be induced to buy more only by lowering price. In other words, when supply increases, price falls. 

 

5.       Regulates Daily Expenditure 

 

This law regulates the daily expenditure of people. People do not spend all their money in same commodity. They spend part of their money in buying other commodities.

 

The Water-Diamond Paradox

The most famous application of marginalism is the solution to the so-called water-diamond paradox, which seemed to stump Adam Smith in his Wealth of Nations.[1]  The problem is this:  Why do diamonds have a higher exchange value than water, when diamonds are a mere frippery while water is essential to life?  Shouldn't people be willing to offer more in exchange for a unit of water than for a unit of diamonds?

The solution, of course, is that no individual is ever in the position of choosing between all of the diamonds in the world and all of the water in the world. A given choice is made on the margin. If offered a choice between a cup of water and a handful of diamonds, most people would pick the latter because the marginal utility of those particular diamonds is higher than the marginal utility of that particular cup of water.

Some economists would describe this situation by saying that diamonds are scarcer than water, because the demand for diamonds relative to their supply is so much higher. Yes, water is more important for human welfare than diamonds, but there is so much water to go around that even if ten trillion gallons were to disappear, no one would care. On the other hand, if only a few pounds of diamonds were to vanish, some people would be very upset.