Advantages of the Law of Diminishing Marginal Utility

Updated on February 27, 2020


In social sciences, you often find that there is a wide gap between theories and their practical application. Have you ever thought why it happens? The answer is very simple. Almost all theories of social sciences are based on general human behavior and certain assumptions. Assumptions are necessary to hold the theory good. However, some of these assumptions are very unrealistic and do not work in all situations. In addition, it is hard to predict human behavior. Hence, theories that rely on such unrealistic assumptions and unpredictable human behavior fail to work in a real life scenario. Because of this reason, there is a wide gap between theories and their practical application. However, the law of diminishing marginal utility is completely different in this regard. Though the theory is derived from general human behavior, it possesses great practical importance. Let us see how the law of diminishing marginal utility is helpful in various fields of economics.

Basis for Progressive Taxation

The law of diminishing marginal utility is one of the fundamental principles in public finance. The law serves as the basis for progressive taxation. Adam Smith explained canons of taxation in his book ‘Wealth of Nations’. One of the canons of taxation is ‘Ability to Pay’. This means that taxes should be imposed according to the ability of people to pay. The law of diminishing marginal utility is crucial in determining people’s ability to pay. According to Prof. Pigou, the marginal utility of money for a poor person is higher than that for a rich person. This is so, because a poor person possesses little money; therefore, the utility derived from each unit of money is huge. This implies that rich people are able to pay more as taxes than poor people are. This concept leads to progressive taxation system, which imposes heavier tax burden on the rich. This is one of the very important practical applications of the law of diminishing marginal utility.

Redistribution of Income

Income distribution is the core concept in public finance. What the government does through taxation is taking away some of the resources from rich and spending them to improve the welfare of poor. Note that when a person possesses less money, the utility derived from it is huge. At the same time, when a person possesses more money, the utility derived from it is less because of the abundance. When taxes are imposed on rich, some of their money is taken away. Hence, the utility derived from the remaining money improves. At the same time, the money taken from the rich is spent to improve the welfare of poor. This implies that the poor becomes better off now. This activity helps to attain an egalitarian society. This process can be explained with the help of the following figure:

Let us suppose that there are two individuals (A and B) in a society. The poor man’s income is OA. OB’ is the rich man’s income. Suppose the government imposes tax on the rich; therefore, income of the rich is reduced by B’B. Now, the same amount of money income is transferred to the poor. This raises the poor man’s income by AA’. From the picture, you can understand that the marginal utility of the rich improves from D’ to D because of taxation. And the poor man’s utility declines from C to C’. This implies that money in the hands of the poor has increased. This activity leads to an egalitarian society.

Derivation of Demand Curve

The law of diminishing marginal utility is the basis to derive demand curve. The law further helps to understand why the demand curve slopes downward. Click here to know how to derive demand curve from the law of diminishing marginal utility. In addition, Go here to understand the relationship between the law of diminishing marginal utility and downward slope of a demand curve.

Value Determination

The law of diminishing marginal utility is helpful to determine the value or price of a commodity. For example, the law explains that the marginal utility of a commodity decreases as the quantity of it increases. When the marginal utility falls, consumers do not prefer to pay high price. Therefore, the seller has to reduce the price of the commodity, if he or she wants to sell more. In this way, the law plays a crucial role in determining price of a commodity.

Water – Diamond Paradox

The principle of diminishing marginal utility is beneficial to understand the difference between value-in-use and value-in-exchange. For instance, let us consider two commodities – water and diamond. Water is essential for our survival (value-in-use) but it is not costly (no or little value-in-exchange). On the contrary, diamonds are useful just for showy purpose (no value-in-use) but they are very costly (high value-in-exchange).

Water is abundant and hence has no marginal utility. Because of this reason, want has no or little value-in-exchange. On the contrary, diamonds are scarce and hence possess a very high marginal utility. Therefore, diamonds have high value-in-exchange. In this way, the law of diminishing marginal utility tells us why diamonds are highly priced when compared to water. This scenario is often referred to as water - diamond paradox.

The following diagram provides you with more information on this paradox:

In figure 2,

UU1 - marginal utility curve for diamond

VV1 - marginal utility curve for water

OA represents the supply of diamond

OF represents the supply of water

Since the quantity of diamonds is less (OA), the marginal utility derived from diamonds is high (AB). Therefore, diamonds are priced high (OC) as the price of a commodity is associated with its marginal utility. Let us look at the case of water. The quantity of water is high. Therefore, the marginal utility derived from water is less (FE). Because of small amount of marginal utility, water is priced less (OD).

Optimum Utilization of Expenditure

The law of diminishing marginal utility is useful for individuals to determine how much money should be spent on a particular commodity. The equilibrium point is where marginal utility is equal to price (point E in figure 3). At this point, we can say that the individual utilizes his or her expenditure optimally. Though we do not calculate all these things in our day-to-day purchasing activities, it happens naturally. We do not pay a high price for a commodity that does not give us utility. In this sense, the law of diminishing marginal utility does play an eminent role in all economic activities.

Basis for Economic Laws

Furthermore, the law of diminishing marginal utility serves as a basis for some important economic concepts such as law of demand, consumer’s surplus, law of substitution and elasticity of demand.

Questions & Answers

    © 2013 Sundaram Ponnusamy


      0 of 8192 characters used
      Post Comment
      • profile image

        goodson kalolo 

        2 years ago

        u guys just served a brother thanks

      • profile image


        5 years ago

        This was useful


      This website uses cookies

      As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

      For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

      Show Details
      HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
      LoginThis is necessary to sign in to the HubPages Service.
      Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
      AkismetThis is used to detect comment spam. (Privacy Policy)
      HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
      HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
      Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
      CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
      Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
      Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
      Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
      Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
      Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
      Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
      VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
      PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
      Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
      MavenThis supports the Maven widget and search functionality. (Privacy Policy)
      Google AdSenseThis is an ad network. (Privacy Policy)
      Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
      Index ExchangeThis is an ad network. (Privacy Policy)
      SovrnThis is an ad network. (Privacy Policy)
      Facebook AdsThis is an ad network. (Privacy Policy)
      Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
      AppNexusThis is an ad network. (Privacy Policy)
      OpenxThis is an ad network. (Privacy Policy)
      Rubicon ProjectThis is an ad network. (Privacy Policy)
      TripleLiftThis is an ad network. (Privacy Policy)
      Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
      Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
      Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
      Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
      ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
      Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
      ClickscoThis is a data management platform studying reader behavior (Privacy Policy)