Diminishing Marginal Utility

Last week I went out to eat pizza with my elder son. We ordered a large pizza and it had 8 slices. I was paying close attention to him as he was enjoying each slice. He consumed the first slice with extreme joy. I gave a value of 100 for the joy he had from the first slice. He was happy eating the second slice but the joy from the second slice was lesser than the first slice. I gave a value of 75 for the second slice. He had 5 slices and tried eating the 6th slice but he could not. The value I gave for each of the slice is given below.

Pizza Slice	Value from each slice	Total Value
0	0	0
1	100	100
2	75	175
3	50	225
4	20	245
5	0	245
6	-10	235

I plotted the pizza slice and the value derived from each slice in a graph.

Next I plotted the pizza slice and the total value derived from it in a graph.

The law of diminishing marginal utility states that if we consume more and more units of a particular commodity, the utility derived from consumption of an additional unit diminishes. This is the reason why each additional pizza gave lesser joy to my son. Hence the curve in the first graph is trending downward. This curve is called as the marginal utility curve.

Now look at the second graph. For each extra pizza slice the curve increases at a decreasing rate. At slice 5 the curve is flat as the marginal utility was 0. At slice 6 the curve moves downward from 245 to 235 as the marginal utility at this point is negative. This curve is called as the total utility curve.

Why is this important?

There are several practical uses of diminishing marginal utility. Some of them are

1. Taxation – In the US tax system is progressive. A decrease of $5000 for someone making $40,000 per annum is more damaging than to someone who is making $1,000,000 per annum. Hence the tax law suggests levying a higher tax on rich and lower tax on poor as to make equal marginal sacrifices.
2. Price Determination – Consumers do not want to pay a higher price for an additional unit. We know that their utility goes down with each additional units. Hence if the firm wants to sell more, it should reduce its price. This is one of the reasons why firms needs to come up with promotions like Buy One Get One free.

Where it does not work?

Diminishing marginal utility does not work in certain situations.

1. Money – The more money one has the more money they want.
2. Alcohol – A person drinking alcohol derives more joy on his second peg than the first. The joy increases with more pegs until he cannot consume anymore.