Law of Demand and Diminishing Marginal Utility!
According to the law of diminishing marginal utility, as the quantity of a good with a consumer increases marginal utility of the goods to him expressed in terms of money falls. In other words, the marginal utility curve of goods is downward sloping. Now, a consumer will go on purchasing goods until the marginal utility of the goods equals the market price.
In other words, the consumer will be in equilibrium in respect of the quantity of the goods purchased where marginal utility of the goods equals its price. His satisfaction will be maximum only when marginal utility equals price. Thus, the ‘marginal utility equal’s price’ is the condition of equilibrium.
When the price of a goods falls, downward sloping marginal utility curve implies that the consumers must buy more of the good so that its marginal utility falls and becomes equal to the new price. It, therefore, follows that the diminishing marginal utility curve implies the downward-sloping demand curve, that is, as the price of the goods falls, more of it will be bought.
The whole argument will be more clearly understood from Figure 5. In this figure the curve MU represents the diminishing marginal utility of the goods measured in terms of money. Suppose the price of the goods is OP. At this price the consumer will be in equilibrium when he purchases OQ, quantity of the goods, since at OQ, the marginal utility is equal to the given price OP’.
Now, if the price of the goods falls to OP’, the equality between the marginal utility and the price will be disturbed. Marginal utility Q, E at the quantity OQ, will be greater than the new price OP’, the consumer must buy more of the goods, it is evident from Fig. 5 that when the consumer increases the quantity purchased to OQ, the marginal utility of the goods falls and becomes equal to the new price OP’.
It is thus, clear that when the price of the goods falls, the consumer buys more of the goods so as to equate the marginal utility to the lower price. It, therefore, follows that the quantity demanded of a goods varies inversely with price; the quantity bought rises when the price falls and vice versa, other things remaining the same. This is the famous Marshallian Law of Demand. It is now quite evident that the law of demand is directly derived from the law of diminishing marginal utility.
The downward-sloping marginal utility curve is transformed into the downward-sloping demand curve. In Fig. 5 (where price is also measured on the Y-axis) marginal utility curve MU becomes the demand curve. It follows, therefore, that the force working behind the law of demand or the demand curve is the force of diminishing marginal utility.