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LAW OF DIMINISHING MARGINAL UTILITY

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UTILITY THEORY

  • Economists assume that the more pleasure a product gives, the higher the price buyers are willing to pay.
  • Students who like butter are willing to pay more for buttered popcorn than non-buttered popcorn because it offers more total utility. 

Total Utility and Marginal Utility

  • Utility is the pleasure or satisfaction obtained from a good or service.
  • Total utility is the amount of satisfaction obtained from entire consumption of a product. 
  • Marginal utility is the change in total utility obtained by consuming one additional (marginal) unit of a good or service.

Calculating Marginal Utility




GRAPH





Law of Diminishing Marginal Utility

  • Though the wants of an individual are unlimited in number yet each individual's want is satiable. Because of this, the more we have a commodity, the less we want to have more of it.
  • This law state that as the amount consumed of commodity increases, the utility derived by the consumer from the additional units, i.e marginal utility goes on decreasing.
  • According to Marshall, “The additional benefit a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has

Explanation: As more and more quantity of a commodity is consumed, the intensity of desire decreases and also the utility derived from the additional unit.

Assumptions:
  • All the units of a commodity must be the same in all respects
  • The unit of the good must be standard
  • There should be no change in taste during the process of consumption
  • There must be continuity in consumption
  • There should be no change in the price of the substitute goods

PRACTICE

Draw graphs of total utility and marginal utility



THEORY OF CONSUMER BEHAVIOR

The theory of consumer behavior uses the law of diminishing marginal utility to explain how consumers allocate their income.

Consumer Choice and the Budget Constraint

  • Budget Constraint - Consumers’ incomes are limited because their individual resources are limited.  
  • Goods and services have prices and are scarce relative to the demand for them.  Consumers must choose among alternative goods with their limited money incomes.

Introduction

  • Recall one of the Ten Principles from Chapter 1:   People face tradeoffs.  
  • Buying more of one good leaves less income to buy other goods.
  • Working more hours means more income and more consumption, but less leisure time.
  • This theory explores how consumers make choices like these. 

The Budget Constraint: What the Consumer Can Afford

  • Example: Hurley divides his income between two goods: fish and mangoes.  
  • A “consumption bundle” is a particular combination of the goods, e.g., 40 fish & 300 mangoes. 
  • Budget constraint:  the limit on the consumption bundles that a consumer can afford  

Preferences:  What the Consumer Wants

Indifference curve:  
shows consumption bundles that give the consumer the same level of satisfaction


A, B, and all other bundles on I1  make Hurley equally happy: he is indifferent between them.


CONCLUSION:  
Do People Really Think This Way?

  • People do not make spending decisions by writing down their budget constraints and indifference curves.  
  • Yet, they try to make the choices that maximize their satisfaction given their limited resources.  
  • The theory is only intended as a metaphor for how consumers make decisions. It explains consumer behavior fairly well in many situations and provides the basis for more advanced economic analysis.