4 Important Practical Importance of Law of Diminishing Marginal Utility

(a) Diversification in Production:

Besides diversification in consumption, the law also helps us in bringing about diversification in the production process. Greater and greater use of the same kind of good makes us feel bored reducing its marginal utility.

To overcome the resistance of the consumers and in order to secure higher profits, the producers continuously introduce newer varieties of the products with new design, shape, colour, technique and presentation.

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(b) Household Expenditure:

This law governs our daily expenditure. Since larger purchases reduce marginal utility, we restrict the purchase of a particular commodity, as we cannot afford to waste our limited resources. We stop further purchases at a point, where marginal utility equals price.

(c) Pattern of Public Expenditure:

The public expenditure should be planned in such a manner that more is spent for the benefit of the poor vis-a-vis the rich. The law of diminishing marginal utility provides justification of the socialist plea for an equitable distribution of wealth.

(d) Basis for Progressive Taxation:

Progressive taxation results when the rate of taxation in­creases with an increase in income of the consumer. The law of diminishing marginal utility is the basis of progressive system of taxation. As the rich have lower marginal utility of money as compared to the poor people due to greater stock of money, they should be taxed at a higher rate.

The modern welfare state imposes progressive income taxation, which means imposition of high taxes on richer sections of the society and low taxes on poorer sections of the society. The taxes so collected are spent for the welfare of the poor people. In this way, Government redistributes income in favour of the poor people.

Income is, thus, transferred from the high – income groups to low – income groups. In this manner, Government tries to increase the nation’s economic welfare. Now, the question arises: Does the transfer of income from rich to poor actually increase the economic welfare? To explain it, let us assume that transfer of income from rich to poor does not affect the incentives to produce.

Now, the question remains of the effect of transfer on satisfaction from consumption. We have already explained that the law of diminishing marginal utility is applicable to money also. As the income of a person increases, the marginal utility of money to him decreases.

In Fig. 4.5, money income is taken along the X-axis and marginal utility of money along the Y-axis. Marginal utility curve for money is downward sloping. Let OL be the income of a poor family and OH be the income of a rich family.

Suppose, income of the rich family is reduced by HH’ and the same is transferred to the poor family, which after the transfer is OL’. LL’ is the increase in the income of the poor family as a result of the transfer from the rich family. It can be seen that gain to the poor family (shaded area above LL’) is more than loss to the rich family (shaded area above HH’). Hence, as a result of the transfer of some income of the rich family to the poor family, the total welfare of the economy increases.