Law of Diminishing Marginal Utility, Assumptions, Limitations, Importance

Law of Diminishing Marginal Utility states that as a person consumes additional units of a good or service, the satisfaction (utility) derived from each successive unit decreases, assuming all other factors remain constant. Initially, the first few units provide significant satisfaction, but as consumption increases, the utility of each extra unit diminishes. For example, the first slice of pizza may bring great joy, but by the fifth or sixth slice, the additional satisfaction reduces. This principle underlies consumer behavior and helps explain demand curves, as consumers are less willing to pay the same price for additional units of a product.

Assumptions of Diminishing Marginal Utility:

• Rational Consumer 

The law of diminishing marginal utility assumes that the consumer is rational and aims to maximize total satisfaction from the consumption of goods and services. The consumer makes choices carefully, comparing the utility gained from each unit consumed with its price. Irrational behavior, such as emotional or impulsive decisions, is not considered under this law. Rationality ensures that the consumer continues consumption only as long as the utility from an additional unit exceeds or equals its cost. This assumption helps in predicting consumer behavior logically and establishing the relationship between consumption and satisfaction.

• Homogeneous Units

Another assumption of the law is that all units of the commodity consumed are homogeneous or identical in every respect — size, quality, and taste. The utility derived from each unit depends only on the quantity consumed, not on differences in quality. If the units vary in quality, the change in satisfaction might occur due to the difference in quality rather than diminishing utility. Thus, for the law to hold true, each successive unit of consumption must be of the same type, ensuring that the reduction in utility results purely from the increased quantity consumed.

• Continuous Consumption

The law assumes that the consumption of units is continuous and without long breaks between successive units. If there is a long gap, the consumer’s desire or hunger for the commodity may revive, and the marginal utility of the next unit might not decrease. For example, if a person eats one apple now and another after several hours, the satisfaction from the second apple might be the same as the first. Therefore, to observe diminishing marginal utility, consumption should be continuous so that the consumer’s desire gradually declines with each additional unit consumed.

• Constant Marginal Utility of Money

This assumption states that the marginal utility of money remains constant while consuming successive units of a commodity. Money is the standard measure of utility, and if its utility changes, it becomes difficult to measure the satisfaction derived from consumption. For example, if a person’s wealth increases or decreases during consumption, the value of money may change, affecting the measurement of utility. To simplify analysis, economists assume that the utility of money remains stable, ensuring that changes in satisfaction are due only to variations in the quantity of the consumed commodity.

• No Change in Consumer’s Taste and Preferences

The law assumes that the consumer’s tastes, habits, and preferences remain unchanged during the process of consumption. If preferences change — due to mood, weather, or health — the level of satisfaction from each unit may also change, making it difficult to observe diminishing utility. For example, a person may enjoy ice cream less in winter than in summer. Therefore, to ensure accurate measurement of marginal utility, it is assumed that the consumer’s tastes, preferences, and external conditions remain constant throughout the consumption process, and only the quantity of the good affects satisfaction.

Explanation with Schedule and Diagram:

We assume that a man is very thirsty. He takes the glasses of water successively. The marginal utility of the successive glasses of water decreases, ultimately, he reaches the point of satiety. After this point the marginal utility becomes negative, if he is forced further to take a glass of water. The behavior of the consumer is indicated in the following schedule:

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.

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 (glasses of water) and the marginal utility gained by different units of commodity. 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. So there is an inverse functional relationship between the units of a commodity and the marginal utility of that commodity.

Exceptions or Limitations of Diminishing Marginal Utility:

• Change in Taste and Preference:

The law assumes that a consumer’s taste and preference remain constant. However, if a person’s preference for a commodity increases, they may derive greater satisfaction from each successive unit. For example, a collector of rare coins may experience increasing utility with every new addition to their collection. This change in taste or habit makes the law inapplicable as the satisfaction level does not diminish but may rise due to psychological or emotional factors. Hence, changes in taste and preference can violate the principle of diminishing marginal utility.

• Abnormal or Addictive Goods:

In the case of addictive goods like alcohol, tobacco, or drugs, the law does not hold true. Instead of diminishing, the utility derived from successive units may increase due to addiction. A habitual drinker, for instance, may feel greater pleasure after consuming more units. This is because their psychological and physical dependence on the product alters their sense of satisfaction. Therefore, for goods that create addiction or dependency, the marginal utility may rise initially before eventually diminishing or causing negative effects.

• Indivisible Goods:

The law of diminishing marginal utility assumes that goods are divisible into small units that can be consumed successively. However, for indivisible goods such as cars, televisions, or houses, this assumption does not apply. These goods are consumed as a whole, and their utility cannot be measured in parts. For example, owning a second car may not provide diminishing satisfaction in the same way smaller consumable goods do. Thus, the law cannot be applied to large, indivisible commodities.

• Irrational Consumers:

The law assumes that consumers behave rationally and aim to maximize satisfaction. However, in real life, people often act irrationally under the influence of emotions, habits, or social pressures. For instance, impulsive buyers or emotional spenders may derive inconsistent satisfaction from goods. Such irrational behavior breaks the assumption of rationality, making the law ineffective. Therefore, the law of diminishing marginal utility is valid only when consumers make logical and deliberate choices in consumption.

• Utility of Money:

The law of diminishing marginal utility does not apply effectively to money. Generally, as people acquire more money, their total satisfaction increases rather than diminishes because money can purchase various goods and services. Although theoretically the marginal utility of money decreases with wealth, in practical life, people seldom experience this decline due to unlimited wants and aspirations. Rich individuals continue to desire more wealth for security, power, and status. Therefore, the satisfaction derived from additional money may not diminish significantly, making the law less applicable to money.

• Improper Time Interval:

The law assumes that units of a commodity are consumed in quick succession without significant time gaps. However, if there is a long interval between the consumption of successive units, the law may not hold true. For example, eating an apple today and another next week may provide the same level of satisfaction because the consumer’s appetite has been restored. Thus, the marginal utility does not diminish due to the time gap. Therefore, for the law to apply, the consumption must occur continuously and without long intervals.

• Durable or Long-Lasting Goods:

For durable goods like furniture, machines, or vehicles, the law of diminishing marginal utility does not apply properly. These goods provide utility over a long period, and their usefulness depends on wear and tear rather than immediate consumption. For example, a person may derive continuous or even increasing satisfaction from using a new car over time. Since these goods are not consumed instantly or repeatedly, the concept of diminishing satisfaction per unit is not relevant in the same way as with perishable goods.

• Related Goods:

The law does not apply effectively when goods are consumed together or have complementary relationships. For example, the utility derived from tea increases when more sugar or milk is added. Similarly, the enjoyment of bread may rise with butter. In such cases, the satisfaction from one good depends on the quantity or presence of another, and the utility of one commodity may increase rather than decrease. Therefore, when goods are complementary or jointly consumed, the principle of diminishing marginal utility may not hold true.

Importance of the Law of Diminishing Marginal Utility:

• Foundation for the Law of Demand

The Law of Diminishing Marginal Utility provides the logical basis for the Law of Demand, which states that as the price of a good falls, the quantity demanded increases, and vice versa. Since the satisfaction gained from each additional unit consumed declines, a rational consumer will only be willing to purchase more units of a good if its price is lower. This inverse relationship between price and quantity demanded is the cornerstone of microeconomics and is directly derived from the psychological reality of diminishing utility, explaining why demand curves slope downward.

• Basis for Consumer Surplus

This law is fundamental to the concept of consumer surplus—the difference between what a consumer is willing to pay and what they actually pay. Because the first units provide higher marginal utility, a consumer places a higher value on them. They may be willing to pay a high price for initial units but only a lower price for subsequent ones. In a market with a single price, they pay less for the initial units than their willingness, resulting in a surplus. This measure of economic welfare is only possible because utility diminishes with consumption.

• Indispensable for Value Theory (Diamond-Water Paradox)

The law solves the classic diamond-water paradox: why is water, essential for life, so cheap, while diamonds, a luxury, are so expensive? The answer lies in marginal utility. The total utility of water is immense, but because it is abundant, its marginal utility is very low. Diamonds have a lower total utility but, due to their scarcity, a very high marginal utility. Price is determined by marginal utility, not total utility. This law thus explains how market value is derived from scarcity and the utility of the last unit consumed.

• Guidance for Public Policy and Taxation

Governments utilize this principle when designing progressive taxation systems and public utility pricing. A rupee taken from a millionaire represents a smaller loss of marginal utility than a rupee taken from a poor person. Therefore, a progressive tax (where the rich pay a higher percentage) imposes a smaller total sacrifice of utility on society. Similarly, for essential goods like water or electricity, a lower initial price block can be set to ensure basic needs are met, aligning pricing with the high marginal utility of initial consumption for low-income households.

• Practical Application in Business and Marketing

Businesses leverage this law in their pricing and sales strategies. “Buy one, get one 50% off” or bulk discounts work because consumers value the second item less. Companies diversify product lines and introduce new models because consumers experience diminishing utility from repeatedly consuming the same good. Understanding that customer satisfaction declines with each additional unit pushes firms to innovate, bundle products, and use sales tactics that align the price with the consumer’s perceived lower marginal utility for additional units, thereby maximizing sales volume and clearing inventory.