7.
Explanation
The Law of Diminishing Marginal Utility is a fundamental principle in economics that states that as a person consumes more units of a specific good or service, the additional satisfaction or utility (benefit) derived from each additional unit will tend to decrease. In simpler terms, it means that as you consume more of something, the extra enjoyment or satisfaction you get from each additional unit becomes smaller. For example, if you’re eating slices of pizza, the first slice might bring you a lot of satisfaction, but as you continue eating, the additional satisfaction from each subsequent slice diminishes.
The Importance of this law lies in its implications for consumer behaviour and resource allocation. It helps explain why people make choices to maximize their overall well-being by allocating their limited resources (such as money) among different goods and services. When the marginal utility of one good decreases, consumers tend to allocate more resources to other goods or services where the marginal utility is higher, aiming to achieve a balance in their consumption.
Importance:
Resource Allocation: The law of diminishing marginal utility plays a crucial role in resource allocation. It guides consumers in making rational choices about how to allocate their limited resources, such as income, to maximize their overall satisfaction.
Pricing and Demand: Businesses and policymakers use this concept to understand consumer behaviour. It helps explain why consumers are willing to pay less for additional units of a good, which is fundamental in determining pricing strategies and estimating market demand.
Public Policy: Governments use this concept to design taxation policies and subsidies. For example, taxing goods with inelastic demand (where marginal utility decreases slowly) can be more profitable for governments.
Consumer Surplus: The law of diminishing marginal utility underpins the concept of consumer surplus. Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. It increases as marginal utility decreases.
Understanding Preferences: Economists use this law to analyse consumer preferences and choices. It helps explain why consumers diversify their consumption across various goods and services to maintain a balanced level of satisfaction.
Conclusion: The Law of Diminishing Marginal Utility highlights the diminishing satisfaction consumers experience as they consume more of a good or service. Understanding this law is crucial for businesses, policymakers, and economists to make informed decisions about pricing, resource allocation, and consumer behaviour.