Importance of Law of Diminishing Marginal Utility
Importance of Law of Diminishing Marginal Utility
The law of diminishing marginal utility is a universal law. Its utility is also universal, that can be explained under two heads: theoretical importance and practical importance.
Theoretical Importance:
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Basis of Socialism:
In the present era the concept of socialism is becoming more prominent. The basis of socialism is the law of diminishing marginal utility. If the national income is distributed unevenly, the major part of the national income will be owned and controlled by few capitalists whereas the majority of the people, they are poor and living in abject poverty. In that case, the total utility will be low because the richer section of society has less marginal utility for the same amount whereas the poor section has more utility for the same amount of money. If the national income is redistributed in such a way that the principle of socialism is followed it will be followed to maximum utility and maximum social welfare.
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Explain the distinction between Value in Exchange and Value in Use:
The concept of marginal utility helps in the explanation of the paradox of value. Adam Smith, the father of economics, was greatly perplexed to know water which is so essential and useful to le has low or even zero price; He could not resolve this ‘water diamond paradox’ the modern economist solved it with the help of marginal utility. It is the marginal utility which is important in the determination of prices not the total utility. It is the marginal utility which is important in the determination of prices not the total utility. Since water is available in abundant quantity and hence its marginal utility is relatively low or even zero, therefore, its price is low or zero. On the other hand, diamonds are available in limited quantity and hence their marginal utility is more so, they command higher prices.
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Basis of Law of Demand:
Why demand curve slopes downward to right? This can also be explained with the help of the law of diminishing marginal utility. As the consumer wants more and more of a commodity, the utility derived from that commodity diminishes and hence he pays lesser price for that. At a higher price, initial commodity is more. Thus the law of demand is based on the law of diminishing marginal utility.
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Basis of Consumer Surplus:
The concept of consumer surplus is also based on the law of diminishing marginal utility. A consumer is ready to pay a higher price for the first unit of commodity and less for the second commodity. It is also based on the law of diminishing marginal utility because he drives more utility from the first unit of the commodity and his utility diminishes with the additional level where its marginal utility is zero, the consumer surplus becomes zero. Hence, the concept of consumer surplus is also based on the law of diminishing marginal utility.
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Basis of Law of Equi-marginal Utility:
The law of equi-marginal utility is also based upon the law of diminishing marginal utility. This law explains the equilibrium of a consumer with the help of his limited resources. It guides the consumer to allocate his resources in such a way that the marginal utility derived from each commodity should be proportionate to its price. Hence, the law of equi-marginal utility is also based on the law of diminishing marginal utility.
Practical Importance:
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Basis of Production:
In the modern economy, there is a diversity in the production of commodities. The goods are different in colour, design and technique. It is simply because if a particular type of commodity is allowed to be produced in large quantities its marginal utility will decline and the profit of the producer will be less. Hence, in order to procure higher profits the technique of production is different in design, shape and technique.
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Basis of Progressive Rate of Taxation :
As you know with the increase in the quantity of a particular commodity is marginal utility declines, so rich people have lesser marginal utility for a unit of money and the poor have got higher marginal utility of same amount of money. Keeping in view, this particular law, the modern governments have framed their technique of taxation as progressive one. In this technique, rich people have to pay higher rate of taxes and poor people pay at a lower rate of taxes.
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Helpful in Determining the Prices:
The law of diminishing marginal utility is helpful in determining the prices. In order to dispose of a higher stock of goods, it is advisable for the producer to charge lower prices whereas if the goods are produced in a small quantity we can charge higher prices.
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Household Expenditure:
The law of diminishing marginal utility governs our daily expenditure. Since we know that a larger purchase will mean lower marginal utility, we restrict our purchase of a particular commodity because we cannot afford to waste our limited resources. We stop further purchases at a point where marginal utility equals price.
Conclusion
The law of diminishing marginal utility is the fundamental law of consumer behaviour which is universally applicable. Many economists feel that this law is not universal in character. In support of their contention, they point out many exceptions or situations where this law does not operate. However, if those exceptions are examined minutely, they do not appear very logical and rational, thus the law is universal law, several economic laws are based on it.
Important links
- Operation of Law of Diminishing Marginal Utility- Causes, Exception
- Law of Diminishing Marginal Utility
- Significance of Business Economics in Decision Making
- Demand and Demand Curve- Explanation & Exception
- Circumstances in which Demand Curve Slopes Upward
- Law of Demand- Definition, Chief Characteristics
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