Principles of Economics -1- I.

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Q. No.1 #
Explain the law of diminishing marginal utility with the help of
schedule and diagram. Also describe its assumptions and limitations.
Ans:

Introduction:
Classical gave the concept of measurable utility and made it obvious with the attainment of
cardinal approach. This approach is based on the notion utility can be measured into numbers
like 10, 20, and 30 with utilo-meter.
Mr. H. Gossen, a German economist, was first to explain this law in 1854. Later on Alfred
Marshall restated this law in the following words:

Definition:
According to Marshall:
The additional benefit which a person derives from an increase of his stock of a thing
diminishes with every increase in the stock that he already has.

According to Chapman:
The more we have of a thing, the less we want additional increment of it.

In simple words:
Other things remaining the same, continuous use of units of a commodity gives less and less
satisfaction (Marginal Utility) till it reaches to zero and then become negative.

Explanation of the Law with Example:

This law can be explained by taking a very simple example. Suppose a person starts drinking
water. The first glass of water gives him great pleasure, the second glass of water gives him less
satisfaction and the satisfaction of the third glass of water is less than the previous one and so on.
The additional utility diminishes with every successive glass of water till it goes down to zero
and then become negative.

Units Margina Total

(Glass of water)l Utility Utility
1 10 10
Schedule: 2 8 18
3 6 24
4 4 28
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5 2 30
6 0 30
7 -2 28
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On taking the 1st glass of water, the consumer gets 10 units of utility, because he is very thirsty.
When he takes 2nd glass of water his marginal utility goes down to 8 units because his thirst has
been partly satisfied. This process continues until the marginal utility drops down to zero which
is the saturation point. By taking the seventh glass of water, the marginal utility becomes
negative because the thirst of the consumer has already been fully satisfied.

Diagram:
The law of diminishing marginal utility can be explained by the following diagram drawn with
the help of above schedule:

In the above figure, the marginal utility of

different glasses of water is measured on the
y-axis and the units (glasses of water) on X-
axis. With the help of the schedule, the points
A, B, C, D, E, F and G are derived by the
different combinations of units of the
commodity and the marginal utility. By
joining these points, we get the marginal
utility curve. The marginal utility curve has
the downward negative slope. It intersects the
X-axis at the point of 6th unit of the commodity. At this point "F" the marginal utility becomes
zero. When the MU curve goes beyond this point, the MU becomes negative.

Assumptions:
Law of diminishing marginal utility is based on the following assumptions.
1. Cardinal Measurement:
The utility is measurable and a person can express the utility in numbers such as 2 utils, 4 utils,
etc.
2. Rationality:
It is assumed that the consumer is rational and his aim is the maximization of his utility.
3. Continuous Use:
The law holds only when units of a commodity are consumed continuously. There should be no
gap or interval between using the units of commodity. A gap or delay in usne may loss the
concept of diminishing marginal utility.
4. Suitable Units:
The law applies when units consumed are of suitable size e.g. when a person is thirsty and he
starts drinking water drop by drop, the utility of water will increase instead of decrease because
the units consumed are not suitable.

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5. Homogeneous Units:
It is assumed that the units consumed should be homogeneous. If the lateral units are superior to
the previous units, the utility of lateral units will increase instead of diminishing.
6. Taste, Fashion, Customs and Habits Remain the Same:
The taste, fashion and habits of a consumer is assumed to be constant during consumption of
successive units of a commodity i.e. a student is eating an apple and during consumption, he is
told that apples are more useful for his memory, the utility will increase rather than decrease.
7. Consumers Income Remain the Same:
The law holds when the income of consumer remains constant during the operation of the law
e.g. if income of consumer increase, his purchasing power increase and demand for goods and
services increase which shows more value i.e. greater utility.
8. Marginal Utility of Money does not Change:
It is assumed that Marginal utility of money to the consumer also remain constant during
successive use of good.

Exceptions or Limitations:
Following are the limitations of the law.
1. Rare Collections:
The law does not hold in the case of rare collection and antiques. If a man is collecting rare
collection, the more he is able o collect, the greater will be his satisfaction e.g. collection of
ancients coins, stamps, paintings etc.

2. Money, Income and Wealth:

The law does not apply to wealth because wealth gives us purchasing power and we like to get as
much wealth as we can. It is said that more wealth a person has, the more he wants.

3. Knowledge:
The law does not apply on knowledge. As a person acquire more and more knowledge his desire
for getting more knowledge increases.

4. Narcotics and Intoxicants:

The law does not hold well in case of narcotics and intoxicants. A person who is addicts of
intoxicants his utility for successive units increase instead of decrease.

5. Fashion and Ostentations:

Utility of a commodity depends upon fashion. A dress in fashion or used to snob and ostentation
has a greater utility and a dress out of fashion has less utility.

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Q. No.2 #

Explain the law of Equi-marginal utility with the help of schedule

and diagram. Also describe its assumptions and limitations.

Ans:

Introduction:
Classical gave the concept of measurable utility and made it obvious with the attainment of
cardinal approach. This approach is based on the notion utility can be measured into numbers
like 10, 20, and 30 with utilo-meter.

Definition:
According to Marshall:
If a person has a thing, which he can put to several uses, he will distribute it among these uses
in such a way that it has the same marginal utility in all.
In simple words:
Other things remaining the same, equilibrium position reaches when marginal utility of all the
commodities purchased are exactly equal.

Explanation of the law:

The basic economic problem arise form the fact that our wants are unlimited and means are
scarce. A consumer tries to spend limited income on different things in such a way that marginal
utility of all things is equal. When he buys several things with given money income he equalizes
marginal utilities of all such thins.

Schedule: Units of
M.U of X M.U of Y
Law of Equi-marginal utility can be explained with the money
help of schedule. 1 16 14
Here we can assume that 2 14 12
(i) Consumer has a given income of Rs.5 3 12 10
(ii) He purchases only two commodities X and Y. 4 10 8
(iii) Price of both commodities are Rs.1 for a unit. 5 8 6
(iv) Marginal utility of both commodities are given. Total 60 50
(v) Consumer is rational.
It is clear for the table that Consumer has various combinations in his mind.
Combination 1:
If the consumer spends whole of his income (Rs.5) on commodity X, total satisfaction is
(16+14+12+10+8) 60.

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Combination 2:
If he spends whole income (Rs.5) on commodity Y, the total satisfaction is (14+12+10+8+6) 50.
Combination 3:
But if the consumer spends 3 units of money on commodity X and 2 units of money on
commodity Y, his total satisfaction will be maximum (16+14+12+14+12=68) because marginal
utilities of last units of both commodities are equal and if consumer spends his income except
this, his total satisfaction will not be maximum. It means that consumer gets maximum
satisfaction when he purchase 3 units of X and 2 units of Y. This is the reason that this law is
called law of maximum satisfaction. This law is also called law of substitution and law
of indifference.

Diagram:
In diagram the units of money are taken on x-axis and
marginal utility at y-axis. Consumer is in equilibrium
position when he is spending 3 units on commodity X
and 2 units on commodity Y but if spend 4 units on
commodity X and 1 units on commodity Y than the gain
in utility is less than loss in utility, so satisfaction will not
be maximum. The only single position where consumer
gets maximum satisfaction is that when marginal utilities
of both commodities are equal.

Exceptions or Limitations:
Following are the limitations of the law of Equi-marginal utility.
1. Measurement of Utility is Impossible:
Utility is a mental phenomenon so it is not possible for a consumer to show utility in numerical
values, so we can neither add, nor compare and equalize utility.
2. Indivisibility of Goods:
The law is not applicable in case of indivisible goods e.g. motorcycle, tractor, cow, and fan etc.
Therefore utility of individual parts can not be compared.
3. Ignorance of Consumer:
Some consumers are not aware of the useful alternatives. Therefore no substitution taken place
and law does not hold true.
4. Snobbery, Ostentation and Fashion:
The law does not hold well when people spend money under the influence of ostentation and
fashion. In such causes they do not equalize marginal utility or tries to attain maximum
satisfaction.
5. Time Period:
It is rare chance that goods purchased are exactly used in given time period. Some commodities
are consumed before the expected period while some goods are used more than the expected
period. So the idea of utility becomes wrong i.e. either we under estimate or over estimate utility.

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