Law of Diminishing Marginal Utility

Definition and Basics

• The law states that as a person consumes more of a commodity, the marginal utility of that commodity decreases.
• Alternative names include:
  • Proportionality Rule
  • Law of Maximum Satisfaction
  • Law of Tuitions
  • Law of Consumer's Equilibrium

Explanation by Marshall

• A person distributes their income among commodities to get maximum satisfaction.
• Example: With ₹2000, purchasing a watch and a dress. Allocation based on maximum satisfaction from each.
• Marginal Utility Ratio: Marginal Utility of Commodity A / Price of A = Marginal Utility of Commodity B / Price of B
• Consumers adjust their spending to equalize the marginal utility per unit of money spent across commodities.

Practical Examples

• Households distribute income (e.g., rent, bills) to maximize satisfaction.
• Ratio calculation ensures maximum utility from limited income.
• Satisfaction is maximized when marginal utility ratios are equal.

Consumer's Equilibrium

• Occurs when the ratio of marginal utility to price is equal for all commodities.
• Example calculations showing equilibrium conditions for commodities A and B.
• Conditions of equilibrium:
  1. MU_A / P_A = MU_B / P_B
  2. Total expenditure matches total income.

Diagram Explanation

• Diagrams illustrate points of equilibrium with marginal utilities and unit prices.

Limitations

• Perfect knowledge of market is unrealistic for consumers.
• Indivisibility of goods: Not all goods can be divided into smaller parts (e.g., TV).
• Uncertainty in consumer choices due to changing market conditions.
• Consumers not always rational in their purchasing decisions.
• Lack of fixed accounting period for calculating utility.
• Utility is subjective and difficult to measure accurately.

Practical Applications

• Basis for consumer expenditure plans to maximize utility.
• Influences decisions on savings and investments.
• Producers use it to allocate resources efficiently for maximum returns.
• Used in determining exchange rates and prices.
• Helps in designing government policies for distribution and taxation.

Conclusion

• While the theory has limitations, its practical uses in various economic fields make it valuable.
• Encourages understanding of consumer behavior and resource allocation.

Additional resources

• Refer to videos on diminishing marginal utility for deeper understanding.

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Note: Ensure to remember multiple names and contexts for law of diminishing marginal utility as they may appear in exams with varied terminology.