Question

"By using the law of diminishing marginal utility, Marshall derived the law of demand, which shows that there exists an inverse relationship between price and the quantity demanded of a good. Comment.

Short answer

Marshall's law of diminishing marginal utility explains the inverse relationship between the price and the quantity demanded of a good in the law of demand. As consumers consume more units of a good, the additional satisfaction (marginal utility) gained decreases due to this law. When the price of a good is high, consumers are unwilling to buy large quantities since the satisfaction gained from additional units is not worth the cost. Conversely, when the price is low, consumers tend to buy more units since the marginal utility is greater than the price. Consequently, the law of diminishing marginal utility demonstrates why consumers buy less of a good when its price is high and more when its price is low, giving rise to the law of demand.

Step-by-step solution

Understanding the Law of Diminishing Marginal Utility

The law of diminishing marginal utility is an economic principle which states that for any individual, the additional satisfaction (also known as marginal utility) gained from consuming an additional unit of a good or service decreases as more of that good is consumed. This means that, after a certain point, consuming more of a good or service brings less and less extra satisfaction.

Understanding the Law of Demand

The law of demand is a fundamental economic concept that states that there exists an inverse relationship between the price of a good and the quantity demanded. This means that as the price of a good increases, consumers will buy less of that good, and as the price falls, consumers will buy more. The law of demand is based on the assumption that consumers will attempt to maximize their satisfaction or utility.

Linking the Law of Diminishing Marginal Utility to the Law of Demand

Marshall derived the law of demand using the law of diminishing marginal utility by considering the consumer's behavior and utility maximization. At first, when a consumer starts consuming a good, the marginal utility from that good is high. As the consumer consumes more of the good, the marginal utility falls, due to the law of diminishing marginal utility. When the price of the good is high, consumers will not be willing to buy large quantities of the good because the satisfaction gained from acquiring additional units is not worth the cost (i.e., the marginal utility is less than the price). On the other hand, if the price is low, consumers are likely to buy more units of the good because the marginal utility still outweighs the price.

Conclusion - The Inverse Relationship Between Price and Quantity Demanded

Marshall used the law of diminishing marginal utility to derive the law of demand, showing that there exists an inverse relationship between the price and the quantity demanded of a good. The law of diminishing marginal utility explains why consumers buy less of a good when its price is high and more when its price is low. As consumers consume more units of a good, the marginal utility decreases, leading them to buy fewer units as the price increases, which gives rise to the law of demand.

Key concepts

Diminishing Marginal Utility

The concept of diminishing marginal utility plays a pivotal role in understanding consumer decision-making. As you consume more of a particular good, the satisfaction, also known as marginal utility, you gain from each additional unit decreases. Imagine eating slices of pizza; the first slice might bring immense joy, but the fifth or sixth slice might not feel as satisfying.
This principle helps explain why people generally won't continue to purchase excessive amounts of one product. As the enjoyment or utility declines, spending money on additional units seems less worthwhile. Therefore, consumers often choose variety over simply consuming more of the same thing.
Key insights of diminishing marginal utility include:

• Higher consumption doesn’t always equate to higher satisfaction.
• Understanding this helps consumers allocate their budget more wisely.

Consumer Behavior

Consumer behavior is how individuals make decisions to use their resources, including time and money, on products and services. Understanding consumer behavior allows businesses to predict how consumers will respond to changes in the market, such as price increases or product launches.
Several factors influence consumer behavior, including:

• Psychological influences: Motivation, perception, and beliefs guide buying decisions.
• Cultural influences: Preferences and behaviors shaped by cultural background.
• Social influences: Relying on opinions of family and friends.

By understanding these behaviors, businesses can tailor their strategies to meet consumer demands, thus maximizing sales and customer satisfaction.

Utility Maximization

The concept of utility maximization is central to making consumer choices. When consumers make purchase decisions, they aim to maximize their overall satisfaction or utility with the resources they have.
Consumers operate under budget constraints, which means they must carefully decide how to spend their limited resources to achieve the highest possible utility. This decision-making process involves comparing the satisfaction gained from various goods and services to find the most fulfilling combination.
Utility maximization involves:

• Balancing the purchase between goods to maintain higher satisfaction.
• Considering alternatives to find better value options.

By focusing on utility maximization, consumers ensure they get the most happiness from their financial expenditures.

Inverse Relationship

The inverse relationship between price and quantity demanded is a fundamental principle of economics. According to the law of demand, when the price of a good rises, the quantity demanded tends to fall, and vice versa. This relationship is graphically represented by a downward-sloping demand curve.
The inverse relationship is explained by:

• Substitution effect: As prices rise, consumers may switch to cheaper alternatives.
• Income effect: Higher prices may erode purchasing power, reducing the quantity consumers can afford.

This core relationship is vital in predicting consumer reactions to price changes and forms the basis of pricing strategies by businesses.

Quantity Demanded

Quantity demanded refers to the amount of a product that consumers are willing and able to purchase at a given price over a specified period. It is different from the overall demand, which might involve various price levels.
Several factors influence the quantity demanded:

• Price of the product: Generally, if prices drop, the quantity demanded increases.
• Consumer income levels: Greater income can increase demand for goods.
• Consumer preferences: Changes in taste may affect how much is bought.

Understanding how quantity demanded fluctuates helps businesses forecast sales, adjust inventory levels, and develop marketing strategies.