Law Of Diminishing Marginal Utility In fact, the fourth slice of pizza has experienced a
diminished marginal utility as well, as it is difficult to
What is the Law Of Diminishing Marginal Utility
The Law Of Diminishing Marginal Utility states that all
else equal as consumption increases the marginal
utility derived from each additional unit declines.
Marginal utility is derived as the change in utility as an
additional unit is consumed. Utility is an economic
term used to represent satisfaction or happiness.
Marginal utility is the incremental increase in utility
that results from consumption of one additional unit.
BREAKING DOWN Law Of Diminishing Marginal
Utility
Marginal utility may decrease into negative utility, as
it may become entirely unfavorable to consume
another unit of any product. Therefore, the first unit of
consumption for any product is typically highest, with
every unit of consumption to follow holding less and
less utility. Consumers handle the law of diminishing
marginal utility by consuming numerous quantities of
numerous goods.
Diminishing Prices
The Law of Diminishing Marginal Utility directly
relates to the concept of diminishing prices. As the
utility of a product decreases as its consumption
increases, consumers are willing to pay smaller dollar
amounts for more of the product. For example, assume
an individual pays $100 for a vacuum cleaner. Because
he has little value for a second vacuum cleaner, the
same individual is willing to pay only $20 for a second
vacuum cleaner. The law of diminishing marginal
utility directly impacts a company’s pricing because
the price charged for an item must correspond to the
consumer’s marginal utility and willingness to
consume or utilize the good.
Example of Diminishing Marginal Utility
An individual can purchase a slice of pizza for $2; she
is quite hungry and decides to buy five slices of pizza.
After doing so, the individual consumes the first slice
of pizza and gains a certain positive utility from eating
the food. Because the individual was hungry and this
is the first food she consumed, the first slice of pizza
has a high benefit. Upon consuming the second slice of
pizza, the individual’s appetite is becoming satisfied.
She wasn't as hungry as before, so the second slice of
pizza had a smaller benefit and enjoyment as the first.
The third slice, as before, holds even less utility as the
individual is now not hungry anymore.
be consumed because the individual experiences
discomfort upon being full from food. Finally, the fifth
slice of pizza cannot even be consumed. The individual
is so full from the first four slices that consuming the
last slice of pizza results in negative utility. The five
slices of pizza demonstrate the decreasing utility that
is experienced upon the consumption of any good. In
a business application, a company may benefit from
having three accountants on its staff. However, if there
is no need for another accountant, hiring a fourth
accountant results in a diminished utility, as little
benefit is gained from the new hire.
Source:
https://www.investopedia.com/terms/l/lawofdiminish
ingutility.asp
Law of Diminishing Marginal Returns
What is Law of Diminishing Marginal Returns
The law of diminishing marginal returns states that, at
some point, adding an additional factor of production
results in smaller increases in output. For example, a
factory employs workers to manufacture its products,
and, at some point, the company operates at an
optimal level. With other production factors constant,
adding additional workers beyond this optimal level
will result in less efficient operations.
BREAKING DOWN Law of Diminishing Marginal
Returns
The law of diminishing marginal returns is also known
as the law of diminishing returns, the principle of
diminishing marginal productivity, and the law of
variable proportions. This law affirms that the
addition of a larger amount of one factor of
production, ceteris paribus, inevitably yields
decreased per-unit incremental returns. The law does
not imply that the additional unit decreases total
production, which is known as negative returns;
however, this is commonly the result.
The law of diminishing returns is not only a
fundamental principle of economics, but it also plays a
starring role in production theory. Production theory
is the study of the economic process of converting
inputs into outputs.
Origins - The idea of diminishing returns has ties to 4. The degree to which the industry is vertically
some of the world’s earliest economists including integrated - vertical integration explains the
Jacques Turgot, Johann Heinrich von Thü nen, Thomas process by which different stages in production
Robert Malthus, David Ricardo, and James Steuart. and distribution of a product are under the
ownership and control of a single enterprise. A
The first recorded expression of diminishing returns
good example of vertical integration is the oil
came from Turgot in the mid-1700s. Classical
industry, where the major oil companies own the
economists, such as Ricardo and Malthus, attribute
rights to extract from oilfields, they run a fleet of
successive diminishment of output to a decrease in
tankers, operate refineries and have control of
quality of input. Ricardo contributed to the
sales at their own filling stations.
development of the law, referring to it as the
5. The extent of product differentiation (which
"intensive margin of cultivation." He was the first to
affects cross-price elasticity of demand)
demonstrate how additional labor and capital to a
6. The structure of buyers in the industry (including
fixed piece of land would successively generate
the possibility of monopsony power)
smaller output increases. Malthus introduced the idea
7. The turnover of customers (sometimes known as
during the construction of his population theory. This
"market churn") – i.e. how many customers are
theory argues that population grows geometrically
prepared to switch their supplier over a given
while food production increases arithmetically,
time period when market conditions change. The
resulting in a population outgrowing its food supply.
rate of customer churn is affected by the degree
Malthus’ ideas about limited food production stem
of consumer or brand loyalty and the influence of
from diminishing returns.
persuasive advertising and marketing
Neoclassical economists postulate that each “unit” of
labor is exactly the same, and diminishing returns are
caused by a disruption of the entire production
process as extra units of labor are added to a set
amount of capital.
Source:
https://www.investopedia.com/terms/l/lawofdiminish
ingmarginalreturn.asp
Market Structure
Key Summary on Market Structures
Market structure is best defined as the organisational
and other characteristics of a market. We focus on
those characteristics which affect the nature of
competition and pricing – but it is important not to
place too much emphasis simply on the market share Source:
of the existing firms in an industry. https://www.tutor2u.net/economics/reference/key-
summary-on-market-structures
Traditionally, the most important features of market
structure are: Perfect Competition

1. The number of firms (including the scale and
extent of foreign competition)
2. The market share of the largest firms (measured
by the concentration ratio – see below)
3. The nature of costs (including the potential for
firms to exploit economies of scale and also the
presence of sunk costs which affects market
contestability in the long term)
Perfect competition describes a market structure,
where a large number of small firms compete against
each other. In this scenario, a single firm does not have
any significant market power. As a result, the industry
as a whole produces the socially optimal level of
output, because none of the firms have the ability to
influence market prices.
The idea of perfect competition builds on a number of
assumptions: (1) all firms maximize profits (2) there
is free entry and exit to the market, (3) all firms sell
completely identical (i.e. homogenous) goods, (4)
there are no consumer preferences. By looking at
those assumptions it becomes quite obvious, that we
will hardly ever find perfect competition in reality.
This is an important aspect, because it is the only
market structure that can (theoretically) result in a
socially optimal level of output. Probably the best
example of a market with almost perfect competition
we can find in reality is the stock market.
Monopolistic Competition
Monopolistic competition also refers to a market
structure, where a large number of small firms
compete against each other. However, unlike in
perfect competition, the firms in monopolistic
competition sell similar, but slightly differentiated
products. This gives them a certain degree of market
power which allows them to charge higher prices
within a certain range.
Monopolistic competition builds on the following
assumptions: (1) all firms maximize profits (2) there
is free entry and exit to the market, (3) firms sell
differentiated products (4) consumers may prefer one
product over the other. Now, those assumptions are a
bit closer to reality than the ones we looked at in
perfect competition. However, this market structure
will no longer result in a socially optimal level of
output, because the firms have more power and can
influence market prices to a certain degree.
An example of monopolistic competition is the market
for cereals. There is a huge number of different brands
(e.g. Cap’n Crunch, Lucky Charms, Froot Loops, Apple
Jacks). Most of them probably taste slightly different,
but at the end of the day, they are all breakfast cereals.
Oligopoly
An oligopoly describes a market structure which is
dominated by only a small number firms. This results
in a state of limited competition. The firms can either
compete against each other or collaborate (see also
Cournot vs. Bertrand Competition). By doing so they
can use their collective market power to drive up
prices and earn more profit.
The oligopolistic market structure builds on the
following assumptions: (1) all firms maximize profits,
(2) oligopolies can set prices, (3) there are barriers to
entry and exit in the market, (4) products may be
homogenous or differentiated, and (5) there is only a
few firms that dominate the market. Unfortunately, it
is not clearly defined what a «few» firms means
exactly. As a rule of thumb, we say that an oligopoly
typically consists of about 3-5 dominant firms.
To give an example of an oligopoly, let’s look at the
market for gaming consoles. This market is dominated
by three powerful companies: Microsoft, Sony, and
Nintendo. This leaves all of them with a significant
amount of market power.
Monopoly
A monopoly refers to a market structure where a
single firm controls the entire market. In this scenario,
the firm has the highest level of market power, as
consumers do not have any alternatives. As a result,
monopilists often reduce output to increase prices and
earn more profit.
The following assumptions are made when we talk
about monopolies: (1) the monopolist maximizes
profit, (2) it can set the price, (3) there are high
barriers to entry and exit, (4) there is only one firm
that dominates the entire market.
From the perspective of society, most monopolies are
usually not desirable, because they result in lower
outputs and higher prices compared to competitive
markets. Therefore, they are often regulated by the
government. An example of a real life monopoly could
be Monsanto. About 80% of all corn harvested in the
US is trademarked by this company. That gives
Monsanto an extremely high level of market power.
You can find additional information about monopolies
our post on monopoly power.
In a Nutshell
There are four basic types of market structures:
perfect competition, imperfect competition, oligopoly,
and monopoly. Perfect competition describes a
market structure, where a large number of small firms
compete against each other with homogenous
products. Meanwhile, monopolistic competition refers
to a market structure, where a large number of small
firms compete against each other with differentiated
products. An Oligopoly describes a market structure
where a small number of firms compete against each
other. And last but not least a monopoly refers to a
market structure where a single firm controls the
entire market.