Download ECONOMICS THE CONCEPT OF UTILITY LAW OF DIMINISHING

ECONOMICS
THE CONCEPT OF UTILITY
LAW OF DIMINISHING MARGINAL UTILITY (LDMU)
The LDMU states that “the amount of satisfaction that an individual derives from an
additional unit of a commodity decreases as its consumption of that commodity increases.
For instance, if someone is very thirsty, he is eager to take the first cup of water and at
this point, he may be willing to pay a relative high price for it.
This first cup of water possesses high level of utility for this individual. However as he
continues to consume more cups of water; the amount of satisfaction dervied from additional
cup will continue to fall until the saturation point is reached, at this point, marginal utility equals
zero.
Here, consumer is perfectly satisfied. Any further consumption beyond this point of
satisfaction will result in disubility or dissatisfaction. As the total utility declines MU declines
further into negative zone.
Table 1: Utility Schedule
Units of Cup of Water
0
1
2
3
4
5
6
7
8
9
Total Utility
20
25
29
32
34
35
35
34
32
29
Marginal Utility
-5
4
3
2
1
0
-1
-2
-3
Notice that marginal utility is obtained with the formula given i.e
TU
MU 
Q
This for the second cup of water
29  25
MU 2
4
2 1
And for the third cup,
MU 3
32  29
 3 and so on
3 2
Table 1:
is put into graph form in Fig 1
Fig 1:
Total and marginal Utility of drinking water
DIAGRAM
The diagram will be provided by the teacher
RELATIONSHIP BETWEEN LAW OF DIMINISHING MARGINAL UTILITY AND NORMAL
DEMAND CURVE
The concept of the law of diminishing marginal utility can be used to explain the slope of
the normal demand curve.
The higher the marginal utility derived from the consumption of a commodity, the higher
the price the consumers are willing to pay for it.
Since rational consumer aims at maximising utility. From the use of his resources in
order to achieve this, the consumer ensures that Marginal Utility (MU) of a commodity is equal
to the price of the commodity.
Note that consumer’s utility decreases as more of a commodity is consumed (LDMU)
and the law of demand says that the lower the price of a commodity, the more of it is
consumed (bought) which means that consumer will only be wiling to pay a higher price for a
commodity whose rate of utility (MU) is high.
This can be explained in the table 2 below:
Table 2:
Price
Quantity demanded
Marginal utility (MU)
5
1
5
4
2
4
3
3
3
2
4
2
1
5
1
(N)
The table 2. above explain two laws:
The first law is the law of demand and the second law is the law of diminishing marginal utility.
From the table 2, it is evidently clear that as the price decreases, more of a commodity
is bought and vice versa which follows the law of demand. Also the amount of satisfaction
derives from the consumption of an additional unit of a commodity falls as more of that
commodity is consumed which confirms the LDMU.
Representing the table 2 above graphically, we have:
Marginal
Utility
5
Price
5
4
4
3
3
2
2
1
1
0
1
2
3
4
Units of commodity
5
0
1
2
3
4
5
Quantity demanded
From the above diagram, it is observed that when Q, yields MU5, the consumer is willing
to pay as much as N5 (price)
From the diagrams and table 2 above, it is observed that the first unit of the commodity
(i.e quantity demanded) yields highest rate of utility (i.e MU5). The consumer is willing to pay as
high as N5 for the highest rate of utility. As the consumption increases as well as the quantity
demanded, the marginal utility (MU) continues to decrease.
The corresponding price that the consumer is willing to pay for units of the commodity
begins to decrease as he is getting towards, saturation point.
A reduction in price will encourage a consumer to consume more of a commodity whose
marginal utility has fallen.
Hence, MU of a commodity must be equal to the price of the commodity
i.e MUx = Px
It is therefore clear that behind the law of demand lies the logic of law of diminishing
marginal utility.
The Concept of Origin
The concept of origin refers to the minimum or smallest quantity of the commodity which
must be consumed before the commodity can yield any satisfaction to the consumer.
For example, a drop of water cannot give any appreciable satisfaction to a person that is
thirstly. There is a minimum quantity of water which he/she must take before he/she starts
deriving satisfaction.
This varies with places, time and person.
The concept of origin refers to the
minimum or smallest quantity of the commodity which must be consumed before the
commodity can yield any satisfaction to the consumer.
For example, a drop of water cannot give any appreciable satisfaction to a person that is
thirstly. There is a minimum quantity of water which he/she must take before he/she starts
deriving satisfaction.
This varies with places, time and person.