Loading the player...

What is the 'Law Of Diminishing Marginal Utility'

The law of diminishing marginal utility is a law of economics stating that as a person increases consumption of a product while keeping consumption of other products constant, there is a decline in the marginal utility that person derives from consuming each additional unit of that product. Marginal utility is derived as the change in utility as an additional unit is consumed.

BREAKING DOWN 'Law Of Diminishing Marginal Utility'

Marginal utility may decrease into negative utility, as it may become entirely unfavorable to consume another unit of any product. Therefore, the first unit of consumption for any product is typically highest, with every unit of consumption to follow holding less and less utility. Consumers handle the law of diminishing marginal utility by consuming numerous quantities of numerous goods.

Diminishing Prices

The law of diminishing marginal utility directly relates to the concept of diminishing prices. As the utility of a product decreases as its consumption increases, consumers are willing to pay smaller dollar amounts for more of the product. For example, assume an individual pays $100 for a vacuum cleaner. Because he has little value for a second vacuum cleaner, the same individual is willing to pay only $20 for a second vacuum cleaner. The law of diminishing marginal utility directly impacts a company’s pricing because the price charged for an item must correspond to the consumer’s marginal utility and willingness to consume or utilize the good.

Example of Diminishing Marginal Utility

An individual can purchase a slice of pizza for $2; she is quite hungry and decides to buy five slices of pizza. After doing so, the individual consumes the first slice of pizza and gains a certain positive utility from eating the food. Because the individual was hungry and this is the first food she consumed, the first slice of pizza has a high benefit. Upon consuming the second slice of pizza, the individual’s appetite is becoming satisfied. She wasn't as hungry as before, so the second slice of pizza had a smaller benefit and enjoyment as the first. The third slice, as before, holds even less utility as the individual is now not hungry anymore.

In fact, the fourth slice of pizza has experienced a diminished marginal utility as well, as it is difficult to be consumed because the individual experiences discomfort upon being full from food. Finally, the fifth slice of pizza cannot even be consumed. The individual is so full from the first four slices that consuming the last slice of pizza results in negative utility. The five slices of pizza demonstrate the decreasing utility that is experienced upon the consumption of any good. In a business application, a company may benefit from having three accountants on its staff. However, if there is no need for another accountant, hiring a fourth accountant results in a diminished utility, as little benefit is gained from the new hire.

RELATED TERMS
  1. Law of Diminishing Marginal Returns

    The law of diminishing marginal returns states that, at some ...
  2. Utility Revenue Bond

    A utility revenue bond is a debt security which is designed to ...
  3. Law Of Diminishing Marginal Productivity

    The law of diminishing marginal productivity is an economic principle ...
  4. Dow Jones Utility Average - DJUA

    The Dow Jones Utility Average is a price-weighted average of ...
  5. Consumption Function

    The consumption function is a mathematical formula that represents ...
  6. Utilization Fee

    Utilization fees are what lenders may charge borrowers, against ...
Related Articles
  1. Insights

    Trust In Utilities

    Even in times of economic turmoil, utilities can be a good investment.
  2. Investing

    Pizza Stock Winners And Losers

    Some pizza makers are hot, while others are just getting burned.
  3. Investing

    The Debt Report: The Utilities Sector

    Discover how blue chip U.S. utilities companies are using debt, and why it was important for the industry to deleverage after the financial crisis.
  4. Investing

    How Huge Is Super Bowl Sunday for Pizza Chains?

    During the big game, American eat a lot of pizza. That's not a surprise, given that the Super Bowl has become as much about having a party as it is watching the game. What may be a bit shocking ...
  5. Investing

    How Utilities ETFs Deal With Rising Rates

    Utilities stocks and ETFs may be vulnerable to rising interest rates, but there are other factors to consider.
  6. Investing

    The Top 5 Utility ETFs for 2016 (XLU, IDU)

    Discover the top utility company ETFs, and learn more about how you can get exposure to water, electricity and natural gas utility companies.
  7. Investing

    Why Pizza Hut Is Making a Big Tech Upgrade

    In the quick-serve pizza space Yum! Brands (NYSE: YUM) Pizza Hut long has trailed fast-growing Domino's (NYSE: DPZ). That has partly been because the Yum! chain has lagged its rival on the technology ...
  8. Investing

    The Top 5 Utility Mutual Funds for 2016

    Understand how utilities equities play a role in asset allocation, and discover the best utilities mutual funds to consider for 2016.
  9. Investing

    Utilities ETFs to Date 2016 Performance Review (UPW, FXU)

    Discover the best and worst performing exchange-traded funds (ETFs) within the domestic and international utilities sector year-to-date.
  10. Investing

    Top 4 Utilities Mutual Funds

    Discover which mutual funds in the utilities industry are top rated, and learn how investors can include utilities as part of an asset allocation strategy.
RELATED FAQS
  1. What are the top investing strategies for investing in the utility sector?

    Employ the right strategies when investing in the utility sector, and you can see consistent returns with less risk than ... Read Answer >>
  2. What is the utility function and how is it calculated?

    Economists measure utility in revealed preferences by observing consumer choices and ordering consumption baskets from least ... Read Answer >>
  3. What is the concept of utility in microeconomics?

    Read about the concept of utility in microeconomics, and why economists disagree about the usefulness of cardinal utility ... Read Answer >>
  4. What is the average annual growth rate of the utilities sector?

    Learn about the average annual growth rate for utilities companies' revenues and earnings per share over the last five years ... Read Answer >>
  5. How many different types of utility stocks are there?

    Learn more about utility stocks and about some of the differences between different kinds of utility companies, including ... Read Answer >>
  6. Does technology follow the law of diminishing marginal returns?

    Learn how workers in the technology industry are affected by the law of diminishing marginal returns, and note the ways that ... Read Answer >>
Hot Definitions
  1. Capital Asset Pricing Model - CAPM

    Capital Asset Pricing Model (CAPM) is a model that describes the relationship between risk and expected return and that is ...
  2. Return On Equity - ROE

    The profitability returned in direct relation to shareholders' investments is called the return on equity.
  3. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  4. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  5. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  6. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
Trading Center