What is Diminishing Marginal Utility?

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Definition:

The law of diminishing utility states that the more a person uses a good or service, the less benefit they gain, and the more likely they are to seek an alternative.

🤔 Understanding diminishing marginal utility

The law of diminishing utility offers an economic explanation for the old saying about having too much of a good thing. The more a person uses a good or service, the less benefit they gain, and the more likely they are to seek an alternative. If one unit of a product provides one unit of value, then do two units of the product give two units of value? Not according to the law of diminishing utility. Instead, the theory states that two units of a product may only offer 1.85 units of value; three units may only offer 2.6 units of value; and so on. The pattern continues until additional units of a good provide almost zero utility.

Example

Imagine you used to play basketball, and you’ve been thinking about getting back into it. You go out and buy yourself a new ball. Since it’s pretty hard to play the sport without the actual basketball, you probably put a lot of value into your new purchase.

Now, suppose your friend heard you were getting back into the sport, so they bought you a new ball as well. You would likely value the gift for the thought behind it. And you may find value in having two balls in case one gets an air leak or becomes lost. But it won’t seem as valuable as that first ball.

What if your partner also bought you a ball? A third ball probably doesn’t hold much value for you. And a fourth ball would generally mean even less. The reduced value of each ball is an example of the law of diminishing marginal utility.

Takeaway

The law of diminishing marginal utility is like playing the same board game over and over…

The first time you play the game, you have a lot of fun. The more you play it, however, the more familiar you become with the rules and strategies. Each time the game becomes less exciting. This is basically how the law of diminishing marginal utility works: Each additional use of a good or service provides less satisfaction until you replace that product with another.

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What is diminishing marginal utility?

The law of diminishing marginal utility says that as people consume additional units of a good or service, the value (aka utility) they gain from each unit decreases. There are two types of utility worth noting:

  • Total utility is the sum of all the value that a consumer gains from using a good or service.
  • Marginal utility is the change in overall satisfaction that comes from consuming more of a product. Let’s say a consumer gains 20 total utility “points” or “units” from drinking one can of soda. If drinking a second can increases the total utility to 25 points, the marginal utility of the drink would be 5 points.

The law of diminishing marginal utility argues that, in the real world, each additional soda consumed provides the consumer with less marginal utility than the one before it. For example, if you drink one soda and gain 20 units of total value, then the second soda you drink will offer slightly less value (say, 15 points), with a total value of 35. A third will offer still less value (say, 10 points). In other words, each additional beverage offers less marginal utility than the last.

Keep in mind that “utility” is a pretty arbitrary measure. There’s no universal utility that comes from eating one slice of pizza, for example. Each person will value a good or service differently. Instead, think of utility as a theoretical tool that economists use to study the value and benefits that different products and services offer to consumers.

What are some examples of diminishing marginal utility?

Food is a common example of a good with diminishing marginal utility. Think of an apple, for example. If you’re starving, an apple offers pretty high value. But the more apples you eat, the less hungry you become — Making each additional apple less valuable.

An experience, like a vacation, can also have diminishing marginal utility. If you’ve never taken a vacation before, then your first one may carry a lot of value or utility. The more frequently you travel, however, each trip may become less exciting. (The same logic could apply to sports games, concerts, plays, etc.)

The utility of additional consumption can even turn negative. Let’s say you’ve caught the flu and need antibiotics. Each dose of medicine helps you recover. If you continue taking the antibiotics past the recommended amount, each additional dose may have less and less benefit, and eventually cause adverse side effects, like destroying healthy bacteria.

Can goods have increasing marginal utility?

In some cases, a good’s marginal utility may increase. For example, if you’re building a three-legged stool, the third leg offers more value than the first two, because the stool would be useless without all three.

Similarly, if you’re building a deck of playing cards, you’ll gain more utility from each card you find until you complete the pack. The more cards you find, the more complete your deck and the closer you are to playing a card game. By this logic, if there are 52 cards in a deck, then a deck of 45 cards has more value than a deck of 32.

Why is diminishing marginal utility significant?

The law of diminishing marginal utility helps explain many scenarios in microeconomics, like the value of a product or a consumer’s preferences.

For example, diminishing marginal utility helps explain how the law of demand works. In most economic models of demand, the demand curve for a product has a negative slope — As its price goes up, demand goes down, and vice versa. If every unit of a given product had equal utility, then as the price dropped, demand would increase without end.

In other words, if the price fell to zero, then in theory, demand would become infinite if the law of diminishing marginal utility did not hold. If a good was free and you got the same value from every unit, then you would naturally want limitless units. For instance, let's assume you play basketball. If basketballs were free, and their value never diminished from one unit to the next, then you would want an infinite number of basketballs — You would feel like you could never have too many.

Diminishing marginal utility also helps explain how a consumer decides to purchase a good or service. If every additional unit of a product offered the same value as the first, then arguably a consumer would spend all of their money purchasing as much of that product as possible. But in the real world, consumers tend to use their money to buy whatever offers the most marginal utility at a given time.

For example, necessities like food and water provide a consumer with a very high value or utility. That is, until the consumer obtains enough food and water to satisfy their physical needs. Once they satisfy this need, the marginal utility of these goods would drop. At that point, the consumer may prefer to purchase other goods that offer more marginal utility.

The law of diminishing marginal utility can have broader applications, like helping economists and governments assess changes to a country’s economy. For example, if a government wants to help the overall economy, it may choose to give more money to the poor, because they will experience more value for each dollar. Someone with only $5,000 will attach more value to each extra dollar than someone with $100,000.

What are the assumptions of the law of diminishing marginal utility?

The law of diminishing marginal utility makes many assumptions about consumer behavior. Here are some examples:

  • Consumers are logical, knowledgeable, and always looking for a good deal. Rational consumers only make purchases that offer the most value, avoiding goods that don’t provide utility.
  • Consumer preferences are static, meaning their sense of value won’t suddenly change due to an outside force, like a new fashion trend.
  • Each unit of a good is equal in size and quality. In other words, the law doesn’t consider the possibility that a higher quality product (think of a mattress), may offer more utility than the same type of product of lower quality.
  • Consumers use a product immediately after purchasing it. This assumption ignores the possibility that while food may provide diminishing marginal value as a consumer gets full, they could store excess food until they’re hungry again — And provide the same marginal utility as the first unit.
  • Money has a static value. If the value of the currency that a consumer uses changes, it can break the law of diminishing marginal utility. For instance, imagine a good went from costing $15 to $30, due to hyperinflation. Or a massive sale reduced a good’s price from $15 to $5. A significant change in price would likely impact the amount of value you assign to each additional unit.

What are the exceptions to the law of diminishing utility?

There are many exceptions to the law of diminishing marginal utility. One exception is that for some products, the marginal utility could increase instead of decrease. Let’s say you’re a married couple that is about to purchase a plane ticket for a vacation. Two tickets would provide more than twice the value of one, because it means they can go on the trip together. Having the company of your partner brings additional value beyond what either of you would experience from going on a solo vacation.

Another common exception to the law involves products with addictive qualities. Do you remember Lay’s Potato Chips slogan, “Betcha can’t eat just one”? The salt and fat in chips can be addictive, which means you might assign an equal or higher value to each successive one you have.

Or think about hobbyists and collectors. Each additional rare item they collect may offer the same or greater utility. Consider a baseball card collector who finds the last card needed to complete a set. They may consider the final card the most prized of the collection, even though they already owned many cards.

How do you calculate diminishing marginal utility?

To calculate diminishing marginal utility, first you need to assign a value to consuming the first unit of a product. The value you assign is arbitrary. For example, you might assign a value of 10 to drinking one can of soda, while another might assign a value of 1.

Once you assign a value to the first unit of good consumed, you can determine how much satisfaction a second unit provides. Then figure out how much a third unit offers, and so on. Again, assigning these values is arbitrary, and different people might value things differently. And keep in mind that diminishing marginal utility isn’t universal — The law makes a set of assumptions and there are exceptions to it.

After assigning values to the consumption of the first and subsequent units, you can calculate the marginal utility of each item and how much the value diminishes.

For example, if one slice of pizza offers 10 utility “points” and two slices offer 19 points, that means the second slice added 9 points in value. That means the satisfaction (aka marginal utility) provided by the second slice decreased by one point (from 10 to 9). If you were to apply this logic to the third slice, then three slices of pizza would offer 27 total utility (10 + 9 + 8 = 27). The total utility equals the sum of each unit’s marginal utility. So, if you had three units of a product, the equation would look like this:

Total utility = marginal utility of first unit + marginal utility of second unit + marginal utility of third unit

In some cases, the marginal utility may not decrease by the same amount for each successive unit. For example, The first unit might offer 10 units of value, then 9.98 (a decrease of 0.02), then 9.95 (a decrease of 0.03), 9.91 (decrease of 0.04), and so on.

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