Overview
This lecture explains the law of diminishing marginal utility as the third reason why the demand curve slopes downward, linking it to how consumers make purchase decisions.
Reasons for Downward Sloping Demand Curve
- The law of demand states that as price falls, quantity demanded rises; as price rises, quantity demanded falls.
- Previous reasons discussed: income effect and substitution effect.
- Third reason: law of diminishing marginal utility.
Law of Diminishing Marginal Utility (LDMU)
- LDMU states that as more units of a good are consumed, the additional satisfaction (marginal utility) from each extra unit eventually decreases.
- Marginal utility is the extra happiness (measured in "utils") from consuming one additional unit.
- Real-life examples: enjoyment of songs or food decreases with repetition or overconsumption.
- After a certain point, extra consumption may cause disutility (negative utility).
Calculating Marginal Utility
- Marginal utility (MU) = Total utility after consuming n units – Total utility after (n-1) units.
- Diminishing marginal utility sets in when each new unit adds less to total utility than the previous unit.
Consumer Choice and Maximization
- Rational consumers allocate spending so the ratio of marginal utility to price is equal across all goods.
- This is called the equi-marginal principle: MU of Good A / Price of A = MU of Good B / Price of B.
- Consumers maximize total utility within their income constraint by equalizing marginal utility per euro across goods.
Effect of Price Changes
- When the price of a good falls, marginal utility per euro spent increases, so consumers buy more of that good.
- When the price rises, marginal utility per euro spent decreases, so consumers buy less.
Key Terms & Definitions
- Demand Curve — A graph showing the relationship between price and quantity demanded.
- Law of Demand — As price decreases, quantity demanded increases, and vice versa.
- Marginal Utility (MU) — The extra satisfaction gained from consuming one additional unit of a good.
- Law of Diminishing Marginal Utility (LDMU) — Each additional unit consumed provides less additional satisfaction than the previous one.
- Equi-marginal Principle — Utility is maximized when the MU/Price ratio is equal for all goods.
Action Items / Next Steps
- Review videos on the law of demand, marginal utility, and the equi-marginal principle as needed.
- Take photos or notes on the example tables for reference.
- Practice calculating marginal utility and applying the equi-marginal principle to different scenarios.