In economics, the law of diminishing marginal utility states that the marginal utility of a good or service declines as more of it is consumed by an individual. Economic actors receive less and less satisfaction from consuming incremental amounts of a good.
Key Takeaways
- The law of diminishing marginal utility explains that as a person consumes more of an item or product, the satisfaction (utility) they derive from the product wanes.
- Demand curves are downward sloping in microeconomic models since each additional unit of a good or service is put toward a less valuable use.
- Salespeople often use different methodologies of soliciting sales as different customers have different reasons for buying a single quantity of an item.
- Marketers use the law of diminishing marginal utility because they want to keep marginal utility high for products that they sell.
- There are several laws of diminishing marginal units, each of which is different but tangentially related across the life cycle of a product.
Understanding the Law of Diminishing Marginal Utility
Whenever an individual interacts with or consumes 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 satisfies the consumer's greatest need. The second unit results in a lesser amount of satisfaction, and so on. For 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.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 a less valuable use.
Areas of Application
The law of diminishing marginal utility is not specific to any industry. Its broad concept relates to different sectors in different ways. In general, it is statistically proved that consumers exert more caution and attention when faced with higher utility propositions. Here are some ways diminishing marginal utility influences processes along a business process.
Sales
The technique of selling goods dramatically changes depending on the consumer's current marginal utility potential. Consider a salesperson who is selling you your first cellphone. With your marginal utility very high with any working cellphone, the sale is easy.
However, if you already own a cellphone, the tactics used by the salesperson (e.g., suggesting a different phone for work, suggesting a backup phone, suggesting upgrading your existing model) will differ. Though not directly linked to the saying "read the room," the concept of diminishing marginal utility is very relatable, as not every client will associate the same utility with a given product. When offered a single free peanut butter and jelly sandwich, for example, some consumers (including those allergic to peanut butter) may have negative utility while most people will have positive marginal utility.Manufacturing and Inventory Management
Companies must be mindful of the law of diminishing marginal utility when planning future production schedules. They can't always rely on historical manufacturing levels, as changes in consumer demand will impact the number of goods needed.
This concept is especially important for companies that carry inventory. The law of diminishing marginal utility can produce a very steep drop-off. Again, consider the use of cellphones. Many people only need one; there is an incredibly large jump in utility from owning zero cellphones to owning one cellphone. Should a market become quickly saturated with people who all own cellphones, a company may be stuck holding inventory.
Marketing
Marketers use the law of diminishing marginal utility because they want to keep marginal utility high for the products that they sell. A product is consumed because it provides satisfaction, but too much of a product might mean 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.
This is an important concept for companies that have a diverse product mix. Imagine your favorite coffee shop. If the shop only marketed a single product, consumers would likely grow tired of that product; its marginal utility would diminish. Marketing professionals must juggle piquing demand for a variety of products to keep consumers interested in numerous products.
Diminishing Marginal Utility vs. Other Measurements
The law of diminishing marginal utility should not be confused with other laws of diminishing marginal units:- Diminishing marginal utility focuses on the consumer aspect and the decreasing nature of demand over time.
- Diminishing marginal productivity focuses on the manufacturing aspect and the decreasing nature of production over time.
- Diminishing marginal return focuses on the merchant aspect and the decreasing nature of profits over time.