key term - Law of Diminishing Marginal Utility

Definition

The law of diminishing marginal utility states that as a person consumes more of a good, the additional satisfaction or utility derived from each successive unit of that good decreases. In other words, the marginal utility, or the benefit gained from consuming one more unit of a good, diminishes with each additional unit consumed.

5 Must Know Facts For Your Next Test

1. The law of diminishing marginal utility explains why consumers typically demand less of a good as its price rises, all else equal.
2. Diminishing marginal utility is a key concept in understanding how changes in income and prices affect consumption choices.
3. Consumers aim to maximize their total utility by allocating their limited budgets across different goods and services.
4. The law of diminishing marginal utility helps explain why consumers typically diversify their consumption across multiple goods rather than specializing in one good.
5. Diminishing marginal utility is a fundamental assumption in the economic theory of consumer behavior and demand.

Review Questions

• Explain how the law of diminishing marginal utility relates to a consumer's budget constraint and the choices they make.
  • The law of diminishing marginal utility states that as a consumer consumes more of a good, the additional satisfaction or utility they derive from each successive unit decreases. This means that consumers will allocate their limited budgets across different goods and services to maximize their total utility. As a consumer's budget constraint limits the total amount they can spend, the law of diminishing marginal utility helps explain why they will diversify their consumption rather than specialize in one good. Consumers will continue to consume additional units of a good until the marginal utility of that good equals the marginal utility of the next best alternative, subject to their budget constraint.
• Describe how changes in income and prices affect consumption choices in the context of the law of diminishing marginal utility.
  • The law of diminishing marginal utility helps explain how changes in income and prices affect consumption choices. As a consumer's income increases, they will consume more of each good, but the marginal utility derived from each additional unit will decrease. This means that as income rises, consumers will allocate their budgets across a wider variety of goods and services to maximize their total utility. Conversely, if the price of a good increases, the law of diminishing marginal utility implies that the consumer will purchase less of that good, as the marginal utility derived from each additional unit is not worth the higher price. The consumer will substitute towards other goods that provide higher marginal utility given their budget constraint.
• Evaluate how the law of diminishing marginal utility shapes a consumer's decision-making process when faced with limited resources and multiple consumption choices.
  • The law of diminishing marginal utility is a fundamental principle that shapes a consumer's decision-making process when faced with limited resources and multiple consumption choices. Consumers aim to maximize their total utility by allocating their budgets across different goods and services. The law of diminishing marginal utility implies that as a consumer consumes more of a good, the additional satisfaction or benefit they derive from each successive unit decreases. This means that consumers will diversify their consumption rather than specialize in one good, as the marginal utility of the next best alternative good becomes more valuable as consumption of the first good increases. Consumers will continue to consume additional units of a good until the marginal utility of that good equals the marginal utility of the next best alternative, subject to their budget constraint. The law of diminishing marginal utility is thus a crucial factor in understanding how consumers make choices to optimize their limited resources and achieve the highest level of overall satisfaction.

Related terms

Marginal Utility:

Marginal utility is the additional satisfaction or benefit a consumer receives from consuming one more unit of a good or service.

Utility:

Utility refers to the satisfaction or benefit a consumer derives from consuming a good or service.

Budget Constraint:

A budget constraint represents the maximum amount of goods and services a consumer can purchase given their limited income and the prices of those goods and services.