What Does the Law of Diminishing Marginal Utility Explain?

The law of diminishing marginal utility explains that as a person consumes an item or a product, the satisaction or utility that they derive from the product wanes as they consume more and more of that product. For example, an individual might buy a certain type of chocolate for a while. Soon, they may buy less and choose another type of chocolate or buy cookies instead because the satisfaction they were initially getting from the chocolate is diminishing.

In economics, the law of diminishing marginal utility states that the marginal utility of a good or service declines as its available supply increases. Economic actors devote each successive unit of the good or service towards less and less valued ends. The law of diminishing marginal utility is used to explain other economic phenomena, such as time preference.

Whenever an individual interacts with an economic good, that individual acts in a way that demonstrates the order in which they value the use of that good. Thus, the first unit that is consumed is dedicated to the individual's most valued end. The second unit is devoted to the second most valued end, and so on. In other words, the law of diminishing marginal utility postulates that when consumers go to market to purchase a commodity, they do not attach equal importance to all the commodities they buy. They will pay more for some commodities and less for others.

As another example, consider an individual on a deserted island who finds a case of bottled water that washes ashore. That person might drink the first bottle indicating that satisfying their thirst was the most important use of the water. The individual might bathe themselves with the second bottle, or they might decide to save it for later. If they save it for later, this indicates that the person values the future use of the water more than bathing today, but still less than the immediate quenching of their thirst. This is called ordinal time preference. This concept helps explain savings and investing versus current consumption and spending.

The example above also helps to explain why demand curves are downward-sloping in microeconomic models since each additional unit of a good or service is put toward less valuable ends. This application of the law of marginal utility demonstrates why a rise in the money stock (other things being equal) reduces the exchange value of a money unit since each successive unit of money is used to purchase a less valuable end.

The monetary exchange example provides an economic argument against the manipulation of interest rates by central banks since the interest rate affects the saving and consumption habits of consumers or businesses. Distorting the interest rate encourages consumers to spend or save according to their actual time preferences, leading to eventual surpluses or shortages in capital investment.

Marketers use the law of diminishing marginal utility because they want to keep marginal utility high for products that they sell. A product is consumed because it provides satisfaction, but too much of a product might meant that the marginal utility reaches zero because consumers have had enough of a product and are satiated. Of course, marginal utility depends on the consumer and the product being consumed.