In economics, the law of diminishing marginal utility refers to the law of diminishing returns. In simple terms, the law of diminishing returns refers to the tendency towards the loss of utility from any increase in the total amount of production, i.e., the more output you make, the less your customers will value your product or service and vice versa. For instance, the law of diminishing returns states that the value of money increases as your production increases, but the number of units you need to produce also decrease. The more units you need to produce, the lower the price. But since the number of units you need to produce increases as your production does, it follows that the cost of your goods or services also increases and so on.
For example, to calculate the law of diminishing returns, we must first assume that there is a perfectly competitive market for all products and services, where prices are both constant and equal. Then, we must calculate the value of each individual commodity or good, which is their marginal revenue cost, and their total satisfaction gained from consumption. We then divide this total satisfaction gained by the total number of consumers and arrive at the final cost of production, which is what the consumers actually pay for. We can then calculate the standard deviation of this final cost, which is equal to the average price of all purchases by a group of consumers.
The law of diminishing marginal utility then helps explain why, if a commodity is produced quickly, its price declines as the quantity produced increases. So if we take coal as an example, its price drops as the number of production increases, until eventually, when production reaches a peak and then the price increases. This law of diminishing marginal utility explains why utility dropped so rapidly with the advent of railroad expansion. It also helps explain why the railroad industry, although highly productive, was able to survive until the Second World War.
Another example illustrates how this law of diminishing marginal utility works in practice. Suppose that I produce some new widget, which my firm can produce quickly. After some initial computation, it turns out that I need to buy a hundred units of widget raw materials in order to produce one widget. In this example, the law of diminishing marginal utility further tells me that if I produce the hundredth unit quickly, I will still be able to make some profit from my sale, but I might have to sell at a lower price to recoup my investment.
This same law of diminishing marginal utility also describes the way in which some physical factors, such as rock, prevent the usefulness of other physical factors, such as heat. If I heat a rock, it becomes unprofitable for me to mine, because the heat will make the rock unprofitable for anyone to mine. Similarly, if I cool a rock, it is no longer valuable for me to mine because it will make the rock unprofitable for anyone to mine. If I were to cool the rock, then the first glass would become valuable for me because of its thermal energy, and therefore, the rock would again become unproductive for anyone to mine.
One more example illustrates how this law of diminishing marginal utility applies in real life. Suppose that I decide to invest in some property, which I believe will become valuable in ten years. Before I spend any money, I calculate the additional units I need to consume every year to pay for the property. Then I calculate the number of additional units I need to consume per year in order to enjoy the property, so that my cost of ownership is equal to the income I extract from the property each year. If ten years from now the property is unprofitable for me to use, then I must immediately withdraw from the investment; otherwise, I will incur a negative value-added tax and my expenditure will exceed my benefit.
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