2 The price system and

the micro economy

Law of diminishing marginal utility

 Utility
The want-satisfying power of a commodity is called Utility

There has been some controversy regarding measuring the utility of a commodity. At one point, it was
assumed that a consumer is able to say exactly how much utility he got from a commodity. The
economists who made this assumption belong to the ‘Cardinalist school of economists. Alfred Marshal
was the most prominent member of this school. But later It was realised that this assumption was
unrealistic. It is not possible to say exactly how much utility we got from a commodity. Utility can not
be measured cardinally.
However it can be measured by ordinally, i.e., it is possible to order the utilities obtained from
different commodities. For instance, A consumer may be able to say that he gets greater utility from 1
kg fish than 1 metre of cloth. In this sense, utility can be ordinally measured. It has been shown that,
for the purposes of economic theory, it is sufficient to assume that utility can be ordinally measured.
Cardinal measurement of utility is not necessary. Economists, who describe to this view, belongs to the
‘ Ordinalist school of economists

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 Measurement of Utility
Cardinal Measurement Ordinal Measurement
1. Utility derived from the 1. Utility derived from the
consumption of any commodity or consumption of any commodity or
commodity bundle is measured by commodity bundle can be
cardinal numbers ( such as 1,2,3,4, measured by ordinal number
etc.) ( such as 1st, 2nd , 3rd etc.)
2. Here, the distance between two 2. Here numerical number is not
cardinal numbers are very important The only important
important . If we consider the thing is the ranking . Let us
example given in our next column, consider the following example:
then the distance between the Commodity Utility Ranking
combination Indicators
cardinal numbers would imply
(1) (2) (1) (2)
higher difference in utility (80-50)
A 40 80 1 1 st st

in the second case than in the first B 25 50 2 2 nd nd

case.
Though (80-50) > (40-25), it is not
important here.

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 Utility
Utility
Utility is another word for satisfaction.

Marginal and total

Marginal utility (MU) is the extra satisfaction gained from consuming another
unit of a good.

Total utility (TU) is the total satisfaction gained from consuming a given
number of goods.

Law of diminishing marginal

utility states that successive units of consumption will eventually lead to a fall
in their marginal utility.

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 Maximizing utility
We assume the aim of rational consumers is to maximize their utility, given the following constraints: a)
limited income b) a given set of prices c) constant tastes.
To maximize utility, consumers will consume up to the point where

This is known as the equi-marginal condition. MU A = Marginal utility of good A, PA = Price of A, etc.

This means that the extra satisfaction per £ on the last unit of good A equals the extra satisfaction per £
on the last unit of good B and that of C and D and so on. If this was not the case, consumers would
reorganize their spending and increase their satisfaction. For example, if the last A per £ was more
satisfying than the last B, the consumers would buy more As and fewer Bs. (They could not have more
ofboth because they are constrained by income.)

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 Relationship between Total and
marginal utility
Marginal utility is the change in total utility when consumption changes by one unit. Conversely.
Total utility is the sum of the marginal utilities of all previous units of consumption.
TU   MU ( Where Σ or ‘Sigma’ sign implies summation. Consider following table:
x x

Number of cups of tea (X) Total Utility (Tux) Marginal Utility (Mux) Average Utility (Aux)

0 0 - -
1 12 12 12
2 20 8 10
3 27 7 9
4 32 5 8
5 35 3 7
6 35 0 5.8
7 32 -3 4.5
8 28 -4 4.0

Tux becomes maximum when Mux=0. if consumes more Mux will fall Mux<0.

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 Relationship between Total and
marginal utility
TU
Mu
E

TU
(+)

0 1 2 3 Quantity

(-)

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Law of Diminishing Marginal Utility
We have assumed that as the consumer’s consumption increases marginal utility decreases. We also
noticed that it is marginal utility, not the total utility decreases. This said to be the law of diminishing
marginal utility. Thus, the law staes that as an individual’s consumption of a commodity increases, the
marginal utility of this person decreases. According to Marshal , ‘ The Additional benefit which a person
derives from a given increases of his stock of a thing diminishes with every increase in the stock that he
already has’.

Reasons behind operation of this law: The basic reason behind this law is an individual’s desire for a
particular commodity is not limitless. It is quite limited in the sense that if he has enough of the
commodity , the intensity of his desire for this commodity will diminish. For instance, A housewife
would say that, she does not desire a second loaf of bread with the same intensity with which she desire
the first. The tenth loaf would probably be quite disliked by her. Expenditure on tenth loaf will simply
wasteful expenditure. The general point is clear enough : ‘ As one goes on increasing the consumption of
a commodity , the marginal utility derived from the commodity goes on falling’.

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 Assumption of Law of
Diminishing marginal utility
The law of diminishing MU is based on the following assumption:
1. Utility is measurable by cardinal numbers
2. The commodity is infinitely divisible into smaller units.
3. The marginal utility of money remain constant
4. The utility from any commodity depends only on the consumption of that commodity
5. The consumer is rational in taking consumption decision.

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 Exception of the law of DMU
There are some exception of the law of diminishing marginal utility.
1. If there is a change in the taste and preference pattern of the consumer then this law may
not be applicable.
2. If successive units of the commodity are not consumed within a given period of time then
this law will not be applicable.
3. In case of joint demand, this law will not work.
4. If a commodity is not divisible by smaller units, t becomes difficult to determine the MU of
such a commodity.
5. If somebody is addicted to drug or alcohol or tobacco, then MU may be rising from
additional consumption.

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 Forces behind the law of demand:
MU analysis
It is important to note that, the theory of the
relationship between MU and price also M
explains why the demand curve is

Marginal utility, price

downward-sloping. Consider the MU curve of
p1
E
the commodity , MU. If the price of the
commodity is OP1, the consumer will demand
OQ1. because it is for that amount that the MU p2
F
(Q1E) equals to the price op1. When op2. the
consumer will demand oq2. As price falls, we
get P<MU. Hence , to establish the equality
between P and MU, the MU should diminish.
The law of diminishing marginal utility, as
U
shown by marshal and his followers , states
that during any particular time period as the 0 q1 q2
consumer consumes more and or units of a quantity
commodity , the additional utility derived
from successive units will gradually fall.

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Relationship between the Marshalian Law of
diminishing Utility and the law of demand
• The probable price can not be zero or Q (Units) Total MU Probable Probable
utility (tk.) Price quantity
negative, we don’t take those values ( 0 and - (Tk.) (P=MU), demand (Q)
Tk. (units0
3). The relationship between P and Q in
a b c d e
columns (d) and (e) establishes the law of
demand ( i.e the inverse relationship 0 0 - - -
1 30 30 30 1
between price and quantity demand). Hence, 2 55 25 25 2
the demand curve is negatively sloped. 3 75 20 20 3
• At any given level of price, the demand of a 4 90 15 15 4
5 100 10 10 5
commodity is obtained from the marginal 6 105 5 5 6
7 105 0
utility curve. 8 102 -3
• It is important to note that the law of
diminishing MU can only explain the normal
demal demand curve, but it can not explain
the abnormal demand curve (positive).

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 Paradox of value
Water is much more essential than
diamonds but people are willing to
pay more for diamonds. This is
because there are relatively few of
them and the marginal utility of
another one is high. The total utility
for them is quite low. However
there is a large amount of water
and so the extra utility of another
unit is low. The total utility,
however, is high.

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03/14/2024 Mohammad Ziaul Alam, HOD, Economcs & bangladesh Studies 14
 Marginal Utility and price:
Consumer’s equilibrium in a single commodity case
Why is it that price is given by the marginal utility of a commodity?
The reason is that a consumer tries to maximize utility. Therefore, he will go on increasing his consumption of the
commodity as long as there is scope for increasing his net satisfaction by doing so. Suppose that, the price of a
commodity is Tk. 5 and the marginal utility of a commodity, at present consumption level is 7. Assume that the
utility of one taka or the marginal utility of money ( Mu m ) is fixed at one unit (Mum =1), i.e., the marginal utility of
tk 5 is (5X1=5) 5. In this case, if the consumer buys an additional unit of the commodity, he will get additional
utility of 7.
On the other hand, he pays a price of tk. 5 for this additional unit.. Hence he loses utility by the amount 5.
therefore, he makes a net gain of 7-5=2 units of utility. Since he makes this net gain for buying the additional unit
of the commodity, he will decide to purchase this additional unit. After purchasing this additional unit, he will
again compare between price and marginal utility. It is now clear that, he will go on increasing his consumption of
the commodity as long as price is less than marginal utility.
With the help of a similar argument, we can show that the consumer will decrease his consumption if price is
greater than the marginal utility. He will keep his consumption just at the level where price is equal to marginal
utility. This is said to be the equilibrium level of consumption.
A consumer attains equilibrium when, given the price of a commodity, he consumes such as a quantity of that
commodity where the net utility is maximum.
Two condition for consumer equilibrium:
i) = ( Mum =1) and ii) is falling.

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 Marginal Utility and price:
Consumer’s equilibrium in a single commodity case ………

Thus, the consumer actually wants to

X TUx MUx TEx NUx Consumer’s
maximize his net utility (NUx ) where NUx =
(units) (Tk.) (tk.) (tk.) (tk.) Surplus
TUx - TEx
(MUx – Px)
Here, TEx = total Expenditure on X
= Px. X = (price of X).(Quantity of X)
NUx reaches a maximum when it does not 1 2 3 4 5= 2 - 4 6= 3 - tk. 1
change even with changes in the consumption
of X. This is shown in the table . In this table 1 5 5 1 4 4
we observed that, if the consumer consumes 3 2 7 2 2 5 1
units of X, then MUx=Px=1. Thus, MU derived
from the consumption of X = MUm of money 3 8 1 3 5 0
sacrificed for the purchase of X (Mum)=Px. So 4 8 0 4 4 -1
Mum =1 (assumed), i) = ( Mum =1) and ii) is 5 7 -1 5 2 -2
falling. Thus, the equilibrium level of
consumption in this case is 3 units of X.
Here, it is assumed that Px =Tk. 1.

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Assumption of Consumer’s Equilibrium
1. Utility is cardinally measurable
2. There is only one commodity and consumer will spend his whole income for that commodity.
3. Utility derived from any commodity depends on only the consumption of that commodity
4. Each commodity is Infinitely divisible and utility of each unit of the commodity can be measured separately
5. Marginal utility of money is assumed constant
6. The consumer is supposed to be rational
7. The taste and preference pattern of the consumer and the income of the consumer remain unchanged
8. The law of diminishing marginal utility holds
Px
MUx

p0

03/14/2024 Mohammad Ziaul Alam, HOD, Economcs & bangladesh Studies 17

 Law of Equimarginal utility
Economists have found a general answer to the Here, by spending PA amount of money, the
question of allocation of a consumer’s income
consumer gets MUA . So by spending 1 unit of
between different commodities. The answer is that the
consumer will behave in such a way that the ratio money, the consumer gets , Similarly, by
between marginal utility and price becomes the same spending PB amount of money, the consumer
for every commodity. In other words, the following gets MUB . So by spending 1 unit of money, the
equality will be established: consumer gets and so on.
If > , the consumer will consume more of A and
If there are more than two commodities, (A,B,C,….) the less of B. As the consumer consume more
equality will take the form: commodity A, MUA will fall. On the other hand,
as he consumes less of B, MUB will rise gradually.
This equality has been called the law of
This process will continue until =
equimarginal utility. It indicates , by spending his
last unit of money either on A, or on B or on C ,
the consumer gets the same marginal utility.

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 Graphic presentation of
Law of Equimarginal utility
𝑀𝑈 𝐴 𝑀𝑈 𝐵
𝑃𝐴
A B 𝑃𝐵

F
E

𝑀𝑈 𝐵 G 𝑀𝑈 𝐴
𝑃𝐵 𝑃𝐴

0A M0 M1 0B

Money Income

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 Assumption of Equimarginal Utility

This law of equimarginal utility is also based on the following assumptions:

1. Utility is cardinally measurable

2. The consumer will spend his whole income for two or more commodities.
3. Utility derived from any commodity depends on only the consumption of that commodity
4. Marginal utility of money is constant
5. The law of diminishing marginal utility holds
6. Each commodity is infinitely divisible, etc.

03/14/2024 Mohammad Ziaul Alam, HOD, Economcs & bangladesh Studies 20

 1. Cambridge International AS and A Level Economics
by Colin Bamford and Susan Grant
2. AS And A level Economics
by Andrew Gillespie
3. AS Economics
by Terry Cook
4. Economics for IBDP
by Jocelyn Blink and Ian Dorton
5. Principles of Economics for ISC class XII
by Asis Banerjee and Debashis mazumdar
03/14/2024 Mohammad Ziaul Alam, HOD, Economics & Bangladesh Studies 21
Department