Practical Importance of the Law of Diminishing Marginal Utility
Practical importance of the law of Diminishing Marginal Utility
The law of Diminishing Marginal Utility has enormous sensible importance. It is used in the discussion of various aspects of economic theory. For example, it is applied to the discussion of the theory of value. The law of Diminishing Marginal Utility furnishes the basis for the law of demand which together with the law of supply influence the determination of value.
In actual life, our attention is always focused on the marginal utility. We are always weighing the utility of buying a little more or a little less of a thing, and we think whether instead we could buy a little more or a little less of something else.
It is through the margin that the law of substitution works, and we are able to arrange our expenditure in such a mariner as to derive the maximum satisfaction. The margin helps us in the utilization of scarce means for the satisfaction of our multiple wants. It determines which wants are to be satisfied and to what extent. As such its practical importance both to the general consumer and to the businessman can hardly be exaggerated.
It is this law which tells us why demand curves slope downwards. As the consumer buys more of a thing, its marginal utility to the consumer falls, Therefore the consumer will be prepared to buy more quantity of the good only when the price of the good falls so as to be equal to the reduced marginal utility. Thus, the law of demand, owing to which the demand curve slopes downwards, is based upon the law of diminishing marginal utility of a good.
As law of diminishing marginal utility applies to money too, this forms the basis of the theory and practice of taxation. It is a common knowledge that the value of money to a rich man is not so great as it is to a poor man. All governments have taken note of it and they have based their system of taxation on it. There is a system of progressive taxation in the case of incomes according to which higher incomes are taxed at higher rates. Thus the theory and practice of taxation is based upon the law of diminishing utility.
The advocates of socialism also take their stand on the law of diminishing utility. They advocate economic equality because the sacrifice of the rich will not be as great as the benefit to the poor. This is so because the utility of money to the rich is less than to the poor.
This law also explains the familiar "diamond-water paradox". Diamonds command high price because of their high marginal utility, which is due to scarcity. Water, on the other hand, is in abundant supply so that its marginal utility is low and hence it has low price. Thus, the law of diminishing marginal utility explains why diamonds are high-priced as compared with water, even though the latter is indispensable for life
How Scarcity Can Change
There are times time that supply and demand can change the demand for certain commodities and products can change.
For example, an extreme drought can raise the demand for water, making it more precious than water. A large diamond find can lower the price for diamonds. High interest rates and or high inflation can raise the demand for gold, thus raising the prices for these particular commodities.
Silver is also a good example. When the economy starts to heat up, the demand for silver also increases, since silver is used in many parts of the economy. It is always important to keep track of the trends of these needed commodities.