Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility

Definition

The law of diminishing marginal utility states that as a person consumes successive units of the same good or service, the additional satisfaction (marginal utility) gained from each extra unit tends to decline. The first unit typically provides the highest utility; later units add less and may eventually produce negative utility.

How it works

• Utility: a measure of satisfaction or pleasure from consuming a good or service.
• Marginal utility (MU): the additional utility from consuming one more unit.
• Diminishing marginal utility: MU falls with each additional identical unit consumed.
• Negative utility: after some point, consuming another unit can decrease overall satisfaction.

Formula:
– MU = ΔTU / ΔQ
(Marginal utility equals the change in total utility divided by the change in quantity consumed.)

Key assumptions

The law generally relies on these conditions:
– units consumed are identical and measurable
– consumption occurs with short intervals between units
– consumer tastes remain stable
– no change in prices of the good or its substitutes
– consumers act rationally

Examples

• Consumer (pizza): The first slice when hungry yields high satisfaction; the second slice gives less additional enjoyment; by the fourth or fifth slice the marginal utility may be very small or negative.
• Business (staffing): Hiring a third accountant may add little extra value if existing staff handle the workload, while hiring an administrative assistant could yield higher utility.
• Product mix (retail): A shop can reduce diminishing marginal utility for customers by diversifying its offerings (e.g., pairing pizza with salads or drinks).

Pricing implications

Because consumers value the first units more, firms often use pricing strategies that reflect declining marginal utility:
– Lower per-unit prices for additional units (bulk discounts) to encourage larger purchases.
– Bundling and product diversification to maintain higher perceived utility across purchases.
Example: A retailer selling backpacks for $30 each, or two for $55 and three for $75, lowers the marginal price to entice buyers who otherwise would stop after the first unit.

Limitations and exceptions

The law may not apply or is weakened when:
– units vary significantly in size or quality
– long gaps occur between consumptions
– goods are collectibles or rare items (value can increase)
– consumer behavior is irrational, influenced by addiction, or mental illness
– the commodity is money (utility of money generally does not diminish in the same way)

Why it matters

The law of diminishing marginal utility helps explain consumer choice, demand curves, and pricing behavior. Businesses use it to set prices, design product bundles, and decide when diversification improves sales and customer satisfaction.

Summary

Marginal utility typically decreases with each additional identical unit consumed. Recognizing this pattern helps economists and businesses predict behavior, set prices, and design offerings that sustain consumer satisfaction.