The price that a consumer is willing to pay for a commodity depends on the MU he expects to derive from it. Therefore, for initial units he will be willing to pay more and for the later units he will pay less.Therefore, as long as the MU derived is greater than the price, the consumer will go on consuming it. The consumer stops at a point where his MU is equal to price. Beyond this point his MU is less than price and, therefore, he will be the loser.
|
Units of consumption |
M U |
Price |
M U. (money) |
comparison |
|
1 |
50 |
0.10 |
.50 |
|
|
2 |
40 |
0.10 |
.40 |
|
|
3 |
30 |
0.10 |
.30 |
|
|
4 |
20 |
0.10 |
.20 |
|
|
5 |
10 |
0.10 |
.10 |
|
|
6 |
5 |
0.10 |
.5 |
Assumption – 1 util = 1 paise Price of the commodity = 10 paise /unit
MU from the consumption of the 5th unit is equal to its price, therefore, the 5th unit is the marginal one. The earlier 4 units are intra-marginal ones where he is willing to pay a higher price, because he desires a higher utility. As he goes on consuming, MU will decrease till its value is equal to price at the 5th unit. He will not buy the 6th unit and this is called the extra-marginal unit. If the price rises to 20 paise per unit and decreases to 5 paise per unit, he is willing to buy till 4th or 6th unit respectively.
This law helps us to understand the paradox of value.
e.g. water is of vital importance to our existance but its supply is greater than demand. It is a free good and, therefore, its consumption can be continued till its MU = 0 therefore, it fetches no price though its TU is high.
A diamond, though limited in utility has high value because its supply is less than demand and cannot be consumed till MU = 0.
MU is high, therefore, price is high though TU is low as compared to water.