Economics 101: What Is Diminishing Marginal Utility? Learn About the Law of Diminishing Marginal Utility in Business With Examples
Written by MasterClass
Last updated: Oct 12, 2022 • 3 min read
How much would you pay for a cell phone? The answer probably depends on your current phone status. If you don’t presently have a phone, you’d likely pay upwards of a thousand dollars for a phone with fast internet connectivity, a great camera, and long battery life. Now let’s say you bought that phone. How much would you pay to acquire a second phone to go along with it? Probably far less than you would have paid for the first one. And you’d pay less still to acquire a third phone. The fact that you’d pay less for each successive phone helps illustrate the law of diminishing marginal utility.
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What Is Marginal Utility?
The phrase “marginal utility” refers to the change in utility of an item as it is consumed over time. But what is its “utility” exactly?
- The item’s utility is its ability to provide satisfying use and/or enjoyment.
- Many items bring their owner immense utility when they are first purchased, but their value diminishes when the owner purchases more of the same item.
- In the case of the cell phone, purchasing one brings an owner from a state of no mobile connectivity to a state of having mobile connectivity; this is a huge leap forward. Adding a second phone doesn’t provide nearly as great a leap forward, and thus the marginal utility diminishes.
What Is the Law of Diminishing Marginal Utility?
The law of diminishing marginal utility states that commodities become less valuable as more of them are acquired. The British economist Alfred Marshall explained the law as such: “During the course of consumption, as more and more units of a commodity are used, every successive unit gives utility with a diminishing rate, provided other things remaining the same; although, the total utility increases.”
What Is the Purpose of the Law of Diminishing Marginal Utility in Business?
The law of diminishing marginal utility applies to business in that it is closely connected to the law of demand. That law states that as price decreases, consumption increases and that as price increases, consumption decreases. Using converse reasoning, we can state that when a commodity becomes more plentiful, the value of an individual unit decreases, and this statement ties us back to the law of diminishing marginal utility.
The law of diminishing marginal utility also connects to the concept of consumer’s surplus. To quote the economist Alfred Marshall: “A consumer is generally willing to pay more for a given quantity of good than what he actually pays at the price prevailing in the market.”
What this means is that if a consumer sees an item on sale for less than what they were expecting to pay, they will quickly snatch it up at this lower price. Inversely, if they see the item listed for more than they assumed it would cost, they are highly unlikely to make a purchase at that time. This concept describes the mental connection between the value (or utility) that a consumer places upon a commodity and the commodity’s actual price.
Businesses use these intersecting laws and concepts as they attempt to predict how consumer choice might affect consumer behavior. The reality of diminishing marginal returns may affect their decision making as they contemplate scales of production.
What Are Examples of the Law of Diminishing Marginal Utility?
In each of these examples of the law of diminishing marginal utility, an individual performs a mental utility analysis to see how much he or she truly wants successive units of the same item:
- A parched person assigns great utility to the first available bottle of water they see. Each subsequent bottle is valuable to the person, but each is less valuable than the one before it.
- A fan of baseball legend Cal Ripken, Jr. is thrilled to receive a baseball with Cal’s autograph. He is also happy to accept second, third, and fourth baseballs that also have Cal’s autograph, but each successive baseball feels less valuable than the one before it.
- A music fan attends their favorite band’s concert and loves it. They gain additional satisfaction from seeing the band many more times, but as their concert consumption increases, the thrill of each additional show is somewhat diminished. In other words, each live show has a diminishing marginal benefit compared to the one before it.
Learn more about economics and society in Paul Krugman’s MasterClass.