The law of diminishing marginal utility

Blessing Nyatanga

The law of diminishing marginal utility alludes that as consumption increases, the marginal utility derived from each additional unit declines. Marginal utility is the incremental increase in satisfaction that results from the consumption of one additional unit.

Utility by definition is an economic term used to represent satisfaction or happiness. To demystify, the law of diminishing marginal utility entails that, the more of an item that you use or consume, the less satisfaction you get from each additional unit.

This article will attempt to dissect how the law of diminishing marginal utility affects both consumers and businesses.

Marginal utility refers to the satisfaction a consumer gets from each additional unit of consumption. It denotes the utility beyond the first product consumed.

If you purchase an apple and then a second one, the utility gained from the second apple is the marginal utility. The law of diminishing marginal utility directly relates to the concept of diminishing prices.

As the utility of a product decreases as its consumption increases, consumers are willing to pay smaller amounts for more of the product.

Let’s assume an individual pays $80 for a microwave. Because he has little value for a second microwave, the same individual is willing to pay only $20 for a second microwave.

The marginal utility <https://www.investopedia.com/terms/m/marginalutility.asp> may degenerate into negative utility. At that point, it’s entirely unfavourable to consume another unit of any product. Therefore, the first unit of consumption for any product is typically highest.

Beyond that, every unit of consumption to follow holds less and less utility ultimately leading to dissatisfaction. Consumers can handle the law of diminishing marginal utility by consuming numerous different goods, keeping the utility high for each one.

The law of diminishing marginal utility directly impacts a company’s pricing because the price charged for an item must correspond to the consumer’s marginal utility and willingness to consume or utilise the good.

Application of the Law of Diminishing Marginal Utility in Business

Businesses can use this principle to structure their workforce.

For instance, a company may benefit from having three accountants on its staff. If the available accountants suffice for the job at hand, hiring another accountant results in a diminished utility, as there is a minimum benefit gained from the new hire.

However, if you have two accountants but no one to process paperwork, hiring a new administrative assistant has a higher level of utility than hiring a third accountant.

The law of diminishing marginal utility can also affect what goods and services businesses offer to customers, as it encourages a certain level of diversification.

In the case of a business that makes pizza’s, if the consumers know they won’t want the fourth or fifth slice of pizza, they might not buy them in the first place. But they may see a high level of utility in a different food, such as a salad. By diversifying its menu, the shop selling pizza can avoid diminished marginal utility and encourage consumers to purchase more.

The law of diminishing marginal utility affects how businesses price their goods and services. Because the first quantity of something has the most utility, consumers are usually willing to pay more for it.

The law of diminishing marginal utility predicts how consumers will react to a certain level of supply.

As they consume more units of a single type of good, the utility of each unit will decrease until the consumer doesn’t want anymore. Businesses can use the law of diminishing marginal utility to understand consumer behaviour, price their goods and services, and diversify their offerings.

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 maximise 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.

Blessing Nyatanga holds a Bachelor’s Degree in Banking and Investment Management from NUST.0784909184/[email protected]