Importance of the law of diminishing marginal utility

Practical importance.

1] Guides the consumer- ( household expenditure ) A rational consumer acts according to this law while arranging  his expenditure and tries to spend his income in a manner in which the consumption yields maximum satisfaction in his given limited income. A consumer will buy the commodity as long as its marginal utility is greater than its price.

2] Guides the producer – It helps he producer in fixing the price of his product..Larger the stock of the commodity lower is its marginal  utility therefore  the producer will then fix a lower price  for his product so as to sell more. A smaller the stock will have will have a higher marginal utility thus the seller will sell his product at a higher price.

3] Guides the monopolist – A monopolist is a single producer and therefore the law helps him ti fix the price of his product. Eg  with a larger stock he will lower the price and with a smaller stock he will raise the price. Or it may also result in the monopolist following a policy of price discrimination  ie he will charge a higher price for the rich as marginal utility of money for them is low and a lower price for the poor as marginal utility of money for them is high.

4] Guides the government

a) Tax and subsidy  policy – A finance minister may decide to levy taxes on the basis of this law. e g a progressive tax on income as marginal utility of money for rich is lower for them Also a subsidy may be provided on public utilities as their for the poor is high eg transport..

b) Social justice – Higher taxes collected  from rich ( progressive income e tax, tax on luxuries etc ) are transferred to the poor in the form of old age pension, free ducation, free medical aid, low cost housing, other subsidy policies  etc. This will also help in achieving a more equal distribution of income and wealth. ( social justice )

Theoretical importance

1] Consumers equilibrium – The law helps us to understand the individual consumers behavior and equilibrium condition with respect to a single want and commodity ( MUx = Px). It shows that a single want can be satisfied at a point of time by consuming more and more of the commodity.

2] Universal truth – Diminishing utility is universal for every consumption, otherwise no single want will ever be satisfied.

3] Helps to understand the concept of paradox of value and of value – in – use and value – in – exchange.

4] It is the basis of the theory consumption   the law of equi-marginal utility, concept of consumers surplus, law of  demand, concept of elasticity of demand etc.

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