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Supply & Demand

Supply & Demand

Diminishing Marginal Utility

Economists use the word utility to describe the ability of a good or service to satisfy some want we possess. A donut has utility if it can satisfy our hunger; a movie has utility if it satisfies our desire for entertainment. Economists also recognize that the ability of a product to satisfy our want or need may diminish the more frequently it is consumed. The first donut you buy may do a great job of satisfying your hunger, the second may as well. But the third may be less satisfying to you, and you may be totally uninterested in the fourth. The once invaluable donut has lost much of its seductive appeal. We might call this the law of diminishing seductive appeal. But economists are a stodgy bunch, so they call this the law of diminishing marginal utility.

Now given our law of demand, we realize that if the donut vendor cuts his price, we may recover some interest. At half price, we might muscle-up for one more 417 calorie chocolate covered cholesterol enhancing treat. But even at a reduced price, utility will eventually diminish until prices drop again and then again and again.

The laws of demand and diminishing marginal utility combine to produce demand curves that predictably flow downward from left to right. The actual market price for a good may change, and that will trigger a change in the number of units sold, but the relationship between demand and price will remain constant—prices and demand will shift in sync with one another along the demand curve.

Economists refer to this sliding along the demand curve as movement. Movement occurs when changes in the market price for a good causes demand to slide up or down the curve—or when a change in the demand causes prices to slide up or down the curve.Demand Curve 2

But economists also recognize the existence of certain factors that will cause the entire curve to shift—move either to the left or the right. Changes in income, consumer tastes or preferences, and in the price of substitution goods and complementary goods will prompt not just movement along the curve but a shift of the curve in one direction or the other.

Why It Matters Today

Imagine you've been lost in the desert, wandering around in the blistering heat without water for days.  Somehow you finally stumble into a roadside oasis, a gas station and mini-mart that has sweet, delicious water for sale.  You'd probably give your left... leg for a bottle.  Your demand for water is off the charts.

So you enjoy that first bottle of water.  You no longer feel like you're about to die.  Your lips are no longer cracked and dry, your throat no longer parched.

You're thinking about maybe buying a second bottle of water.  But you don't need it.  You'd pay a few bucks for it, sure, but it's no longer of nearly priceless value to you.

That's diminishing marginal utility.

Sometimes, a Song Says it Better: New Morning, by Alpha Rev

He doesn’t need to be rich. Additional wealth has diminishing utility.

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