Why do people spend more money on some products than others? Laws of supply and demand are frequently cited in response, but what exactly are these laws? The law of declining marginal utility contains the solution.
Most economists use the satisfaction one feels after consuming a good, such an ice cream cone, to explain this concept. It's possible that eating a second cone will leave you feeling less satisfied than eating a first cone, and so on. According to mainstream economic theory, as we consume more of any good over time, the satisfaction or utility we gain from each new unit decreases, and as a result, so does the price that one is prepared to pay per unit.
Economists can use mathematics to determine the added satisfaction and total utility by quantifying utility. As a result, the law of falling marginal utility results from the decreased enjoyment of using a specific good. An individual feels satisfied after eating multiple ice cream cones, causing human conduct to depend on biological demands rather than reason. Ludwig von Mises once said, "It is impossible to describe any human action if one does not refer to the meaning the actor sees in the stimulus as well as the end his response is aiming at."
The Menger Explanation
The founder of the Austrian school of economics, Carl Menger, asserted that people prioritize different objectives based on how important they are to satiating their wants. The highest rankings are given to those goals that people believe are most crucial to sustaining life, while lower rankings are given to goals that are viewed as less crucial.Think of John the baker, who makes four loaves of bread to aid him with his necessities. Assume that he has one loaf of bread for personal use and the remaining three loaves are for other purposes.
John discovers a tomato farmer who is willing to trade five tomatoes for a loaf of bread, enabling him to accomplish his second-most essential aim of eating five tomatoes. John trades the third loaf for a shirt, the third-most significant end. John finally gives his fourth loaf to the wild birds to feed.
John traded his resources, loaves of bread, for commodities that would further his second and third aims. Because a shirt was more beneficial to John than a loaf of bread, John traded it in. Consequently, the first loaf of bread protects the most crucial end, the second, the second most crucial end, and so forth.
Least Important End Sets the Standard of Valuation
John assigns each loaf the value derived from its use as food for wild birds, which is the least valuable goal. Why does he act this way? (John can use any of his four loaves. This suggests that, in John's eyes, each loaf will be equal in value.) Assume, instead, that John values the second, third, and fourth loaves higher than the ends he acquires because he uses the highest end as the benchmark when determining the worth of each loaf of bread.If so, then why would he trade something more valuable for something less valuable? In such a case, the subsequent exchanges would not take place. But if John is still exchanging, the value of the remaining three loaves must be dwindling.
Keep in mind that John's whole supply ends with the fourth loaf of bread. Additionally known as the marginal unit. According to John, the marginal unit offers the least benefit because this loaf achieves the least crucial goal.
If John only had three loaves of bread, each loaf would be valued in accordance with the goal that was accomplished by the third loaf—having a shirt since it is valued higher than feeding wild birds—in this scenario. This suggests that the marginal utility of bread increases as the supply decreases. As the quantity of bread declines, each loaf is worth more than it once was. On the other hand, as the supply of bread increases, its marginal utility decreases, and each extra loaf has a lower value than it had prior to the growth in the supply.
In John's situation, the worth of bread from a particular supply is determined by the least significant loaf of bread. Because the marginal loaf of bread serves the least important aim, as the quantity of bread increases, its unit value will decrease.
People Do Not Set Arbitrary Goals
Instead than pursuing arbitrary goals, people use the resources at their disposal to try to maintain their quality of life. Instead, they prioritize meeting their most urgent demands before focusing on less critical objectives. For instance, John would not have enough to eat if he had arbitrary devoted the majority of his resources to feeding wild birds.Furthermore, contrary to what the dominant viewpoint portrays, marginal utility is not an increase in total utility but rather the utility of the marginal end. Utility is not about amounts, but rather about priorities or the rankings that each person establishes. Of course, priorities can be given cardinal values. Since there is no such thing as total utility, the mathematical techniques used in economics and modern portfolio theory to calculate total utility and marginal utility are dubious.
Conclusion
The law of diminishing marginal utility is at the core of price setting. According to conventional economic theory, this law relates to the reality that individual satisfaction with a given commodity decreases as its supply rises. Therefore, the fundamental factor in deciding a good's price is the degree of satisfaction.Instead, a good's worth is determined by how well it serves a person's needs. Ordinarily, we rank products based on how well they can meet our demands. Mathematical concepts are not necessary in this situation.
