‘Utility’ a word associated with the consumption of a product/service in the world of economics. Why knowing about utility is important in economics? Because one part of the economics deals with demand and supply as well as individual/group behavior. Imagine a factory keeps on producing the product ‘X’ whereas there are not enough people to consume it. Results would be devastating. Therefore, understanding how the product is being consumed becomes essential. The law of Diminishing Marginal Utility (commonly referred to as DMU) explores the depths of consumption.
The utility is the amount of satisfaction derived from consuming a product/service. But in reality, how can we measure the satisfaction level because it is relative in nature. There can be no common unit or matrix for satisfaction. Most of the theories have their assumptions and therefore economics is an incomplete science. Even if you have a theory there is no solid proof of that, unlike the scientifically tested theories.
In this blog post, I will try to cover the overall aspects of Diminishing Marginal Utility (DMU) and explain in as simple a manner as possible. Because sometimes understanding the concept becomes fruitless if you do not understand the relevance of it in the day to day life.
Here Is All You Need To Know About The Law Of Diminishing Marginal Utility (DMU):
The History Of Diminishing Marginal Utility
Human beings have been consuming food and other products since the stone age. Nobody put the thoughts behind it initially. As civilization evolved and thinkers started paying more attention to our individual and social behavior. The concept of utility came from the same. The exact origin is still debatable but for the sake of this article, we will assume that it started from one of the greatest philosophers Aristotle.
A few centuries later, came the famous ‘water and diamond paradox’. This paradox was based on the grounds that water which is so essential for human beings gets traded at a cheaper value. Whereas, diamonds which practically have no necessity or impact on our lives gets traded at a higher value. A person can survive without buying a diamond for a lifetime but will not survive for more than 7 days without water. A lot of thinkers had their own set of views regarding the solution for this paradox.
Many economists over the years tried contemplating inclusive theories to explain the concept of utility. Some of them did not pursue the thought, a huge amount of the work was never published, and some got heavily criticized by society. Then came, Adam Smith who quantified the demand and came up with the famous demand curve. Later came Alfred Marshall who promoted the concept of marginal utility in his book ‘Principles of Economics. This is what we uphold to date.
Concept In A Nutshell
What is Diminishing Marginal Utility? In a nutshell, it means that with every unit of consumption the utility reduces. The common explanation usually takes a fruit or food item as an example to explain the concept. But what we need to understand is that DMU goes beyond that. Utility means the satisfaction derived from consuming a product/service. Measuring that satisfaction derived from each time you consume the same product/service is different. With every marginal unit, you consume the utility decreases (diminishes) and that is DMU.
Putting it in a realistic manner, if you buy 1 white shirt because you had none, the amount of joy you will have is immense, for the sake of this example, we will say 100. The next day you buy another white shirt (same fabric, same brand, same price, etc.). The amount of satisfaction will not be as much as the previous shirt so let’s say it is 80. The next day you buy another white shirt (after already owning 2 same shirts) and the amount of satisfaction will reduce to 60. This happens till the day you find only white shirts in your closet. Things might be different if you are Mark Zuckerberg.
This what the whole concept of Diminishing Marginal Utility is all about. Everything being constant, with every white shirt you buy or every additional product/service you consume, the satisfaction derived from it goes on reducing till zero. Now, having a negative satisfaction is debatable. If you are fed up with buying white shirts, you will stop buying them but I do not see any negative impact of that.
Assumptions Of The Law
If you have observed, I have been emphasizing ‘everything being constant’ while explaining the concept. Because the initial building block of every theory is an assumption. In order to prove or disprove a concept, you need to first form a hypothesis. In order to form that hypothesis, you need to have certain assumptions in mind. Similarly, there are few assumptions in the Diminishing Marginal Utility. They are as following:
Rational Consumer: It is assumed that the person is of sound mind and rational in terms of consumption. A person who is obsessed with buying only white shirts will be excluded from the experiment because he/she will be an outlier.
Homogeneous product: The product must be homogeneous in every manner. Same shirt, brand, price, store, size, everything must be the same for the example to work successfully.
Continuous consumption: In order for the DMU to work consumption must be at a constant pace. It can be hourly, daily, monthly depending on the commodity. Therefore in the example, I mentioned buying the shirts every other day.
Fixed income and prices: The DMU assumes that the income and subsequent standard of living of the person will remain fixed and also the price of the commodity (in our example the white shirt). This has been highly debated as it cannot remain constant every time.
Cardinal and monetary measurement of utility: It is also assumed that the utility or satisfaction can be measured in cardinal numbers like 1, 2, 3, and so on. This is what makes it easier to plot the graph for the concept.
Reasonable consumption: The final assumption is that the consumption is reasonable. If the first item is too much or too less then the laws of DMU will not apply.
Limitations/Exceptions Of DMU
The world of economics is filled with thinkers, philosophers, and economists who are ready to critique the work of their predecessors and challenge the status quo. Just like there are assumptions, there are certain limitations and exceptions to every law. Here are the limitations/exceptions to the law of Diminishing Marginal Utility (DMU):
Hobbies: The law of DMU does not apply to hobbies. If one has a hobby of playing violin then they will get more satisfaction with every song/tune they play or compose.
Durable goods: Durable goods are something that cannot be continuously consumed and hence cannot be analyzed under the law of DMU.
Precious/luxurious items: Just like durable goods, there are numerous precious or luxurious items like gems, diamonds, rare art pieces, etc. The satisfaction derived from owning them cannot be measured and it will generally give more satisfaction with every additional unit owned. Hence, this is an exception.
Human emotions: Economics studies human behavior at the individual as well as group level. One of the assumptions requires the individual to be of sound mind. But even then, people have emotions and things that influence their buying/consumption decisions. Depending on the mood or the atmosphere the amount of utility derived from the consumption varies. This is not taken into account for DMU.
Money itself: Money itself as a commodity defies the laws of Diminishing Marginal Utility (DMU). In today’s world where everyone is aiming to accumulate more and more money, the marginal utility received from every additional unit increases (Even if the individual is the richest person on the planet). Therefore, the concept of money is an exception to the laws of DMU.
Relevance In Life
Finally, it is important to understand what is the relevance of Diminishing Marginal Utility (DMU) in real life? Surprisingly, it more relevant to sellers than consumers. Because from a consumer’s end one knows exactly how much utility is derived from consuming one product/service. It is the seller’s job to make sure that the customer is getting optimum utility. In the perfectly competitive market setup, there is no shortage of sellers and buyers. But a seller needs to make sure the customer comes back to their shop on a recurring basis.
This customer satisfaction supremacy has made the sellers think more about the experience customers are getting. Therefore, companies spend a huge amount of resources on the Research and Development (R&D) Department. All of these efforts are done to make the customer feel that they are experiencing more utility with every unit consumed.
Examples of these efforts can be seen in the atmosphere of the shop, the walls are painted with vibrant colors, on the menu card you find innovative names for simple dishes, the executives behave more politely than the store next door, etc. Not only that, but the online stores also make sure that the customers get value for their money. All of this is influenced by the fact that utility diminishes with every additional unit consumed.