Marginal Utility is the change in utility as an additional unit is consumed. The law of marginal utility states that when everything else is kept constant, as the consumption increases, the marginal utility derived from each unit decreases (diminishes). The law of diminishing marginal utility means that if a person consumes more of something, the satisfaction or the utility they derive from it decreases. For example, suppose some people like fried chicken. If the person consumes fried chicken on a daily basis, his interest in it will decline. This is exactly the principle behind the law of diminishing marginal utility. In economics, it is almost the same thing. Whenever the supply of a certain product increases, the marginal utility of the product will always diminish.
Consider the above table for units of consumption of fruits. Marginal utility is the utility added by each unit of fruit. It starts at 20 and keeps on decreasing as we eat more fruit. After 5 fruits, the marginal utility becomes zero and at the 6th fruit, it is very hard to consume the fruit and hence, the marginal utility is negative. The total utility decreases because of this and falls from 50 to 45. Here, it is apparent that a number of units increases, the marginal utility will always decrease.
The law of diminishing marginal utility is also known as Gossen’s first law. It is a very important microeconomics theory and is widely used in a lot of companies. The best use case for the law of diminishing marginal utility is in the case of finding the number of units to manufacture in order to make the most profit. Of course, a demand analysis must also be made in order to find the best profit. But, in this case, the units of consumption leading to the highest total utility will be considered. In the above case, this could be 4 or 5. Then, a demand analysis is also made to see which of the options is more viable and within the budget. This will give us the best estimate of the number of units to be produced in order to reap the most profits. So, they must ensure that satisfaction is to be sold such that the marginal utility never drops to zero and sales are always high.
There are certain assumptions made for the diminishing marginal utility to be true. These include unchanging consumers’ mental state, a unit of good should not be very small. In very small cases, this might not work. Although we have used small quantities in our example, it is only to illustrate the fact. It doesn’t work very well with small units of consumption. There are also certain exceptions for the law of diminishing marginal utility like in any law of microeconomics. The law of diminishing marginal utility is a very important law of microeconomics and is used very extensively. It is very crucial for everyone to know about this law as this comes up often even in day to day life.