When average utility attains maximum value, it is equal to marginal utility.
Law of Diminishing Marginal Utility
It is a general human behavior that as one gets more and more units of the same commodity, the utility from the successive units (marginal utility) goes on diminishing. If the consumer continues with the consumption he will develop a dislike for the commodity. Law “The utility which a consumer derives from the consumption of each additional unit of a commodity keeps decreasing with every increase in the stock of the commodity which he already has”
1. Rationality :- Consumer is rational and he aims at the maximization of his utility subject to the constraint imposed by his given income.
2. Cardinal Utility :- Utility is measurable and it can be quantified. It can be added, subtracted, multiplied & divided.
3. Independence of Utility:- Utilities of different commodities are independent of one another.
4. Continuous Consumption Process :- The law assumes that there is no time gap between the consumption of two successive units of the commodity. It there is a discontinuity in the consumption, the intensity of want get revived.
5. Homogenous Units of Commodity :- If a delicious ripe mango, is eaten after consuming an unripe mango, the second mango may give greater utility.
6. No. Change in Personal, Social & Mental Conditions of Consumer:-His income, tastes, fashions & habits should not change.
7. Constancy of Marginal Utility of Money ;- I.e. marginal utility of money is constant. If the unit of measurement itself varies, then it will give different results in different circumstances for the same quantity of good.
Importance of Law
1. Basis of Law of Demand :
The price which a consumer is prepared to pay for a commodity depends upon the marginal utility and not on the total utility. He would like to by additional units of the commodity only at a lower price. Thus a consumer is ready to pay higher price for the initial units and lessor for the additional ones.
2. Explanation of Diamond/ Water Paradox :-
Since water is available in plentiful quantity its marginal utility is low or even zero. Therefore its price is very low, yet it is essential for human existence. On the other hand, diamond being a scarce commodity commands a higher price due to its higher marginal utility, though not essential for human existence.