The Most Important Applications of Diminishing Marginal Utility Law are listed below:
(A) Marginal Utility of Money:
Ordinarily people think that the law of Diminishing Marginal Utility will not be applicable to money. The more the money a man gets the merrier he will be. Money represents the generalised purchasing power.
Money is not a commodity but a bundle of commodities. With the help of money we can purchase anything we like. So more money does not bring dissatisfaction nor marginal utility of money does diminish.
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This is not true. The law also applies to the stock of money. If a man has more stock of money he is a rich man. If he has got less stock of money he is a poor man. A rich man is not as careful about his money, as a poor man, other thing remaining the same.
If a rich man loses a rupee he does not bother but if a poor man loses a rupee he searches for it. Government servants at the beginning of the month when they receive their monthly salaries they spend recklessly. But in the last week of the month when the stock of money decreases they cannot spend so lavishly.
It follows, therefore that with increase in the stock of money its marginal utility decreases. But then the question arises is there no difference between the application of the law for money and any other ordinary commodity? There are two differences.
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In the first place the law applies slowly to money incomparision to other commodity. Secondly in case of other commodities marginal utility may be zero or negative but in case of money the point of maximum satisfaction never reaches. The marginal utility of money can never be zero.
(B) Price and Marginal Utility:
Price or the exchange value of a commodity is an indication of marginal utility. A consumer stops further consuming the commodity where price is equal to marginal utility.
If he stops before this point of equality he is a loser because he could have got some more utility in excess of price which he will lose. In our hypothetical example suppose the price is equal to 10 units of chocolate.
This is the fourth unit of commodity. From the earlier units he got 25, 20, 15 units of utility. So here he was getting more utility than that he was parting in terms of price i.e., 10 units. Therefore if he stops before he is a loser.
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If he proceeds to consume the fifth unit he will loser because from the unit of the commodity he will get 5 utility and in terms of price he will pay 10 utility. So he is loser.
Therefore price and marginal utility are always equal. If price falls marginal utility falls and if price rises marginal utility rises. When price falls consumer purchase more to make both of them equal and when price rises they purchase less. This relationship between MU and price forms the basis of law of demand where MU = P.