Practical Importance of Law of diminishing marginal utility

Practical Importance of Law of diminishing marginal utility

The law of diminishing marginal utility has great practical importance in economics. The law of demand, the theory of consumer’s surplus, and the equilibrium in the distribution of expenditure are derived from the law of diminishing utility.

1. Basis of the law of demand: The law of diminishing marginal utility and the law of demand are very closely related to each other. In fact the law of diminishing marginal utility, the more we have a thing, and the less we want additional increment of it. In other words, we can say that as a person gets more and more of a particular commodity, the marginal utility of the successive units begins to diminish. So every consumer while buying a particular commodity compares the marginal utility of the commodity and the price of the commodity which he has to pay.

If the marginal utility of the commodity is higher than that of price, he purchases that commodity. As he buys more and more, the marginal utility of the successive units begins to diminish. He tries to equate at every step the marginal utility and the price of the commodity, he must lower its price so that the consumers are induced to buy large quantities and this is what is explained the law of demand. From this, we conclude that the law of demand and the law of diminishing return are very closely inter- related.

2. Consumer’s surplus concept: The theory of consumer’s surplus is also based on the law of diminishing marginal utility. A consumer while purchasing the commodity compares the utility of the commodity with that of the price which he has to pay. In most of the cases, he is willing to pay more than what he actually pays. The excess of the price which he would be willing to pay rather than to go without the thing over that which he actually does pay is the economic measure of this surplus satisfaction. It is in fact difference between the total utility and the actually money spent.

3. Importance to the consumer: A consumer in order to get the maximum satisfaction from his relatively scarce resources distributes his income on commodities and services in such a way that the marginal utility from all the uses are the same. Here again the concept of marginal utility helps the consumer in arranging his scale of preference for the commodities and service.

4. Importance to finance minister:Sometimes it is pointed out that the law diminishing marginal utility does not apply on money. As a person to collect money the desire to accumulate more money increases. This view is superficial. It is tire that wealth is acquired for the procurement of goods and services and man is always anxious in getting more and more money. But what is the utility of money to him? Is it not a fact a person gets more and more wealth, its utility progressively decreases, though it does not reach to zero?

For example, a person who earns Tk. 90,000 per month attaches less importance to Tk. 10. But a man who gets Tk. 1000 per month, the value of Tk. 10 to him is very high. A finance minister knowing this fact that the utility of money to a rich man is high and to a poor man is low bases the system of taxation in such a way that the rich persons are taxed at a progressive rate. The system of modern taxation is therefore, based on the law of diminishing marginal utility.