Marginal Utility of Money

The law of diminishing marginal utility is not fully applicable to money, rather it is partially applicable. This is because money represents generalized purchasing power. It does not represent a single commodity but almost all the commodities transacted in the market. Therefore as the stock of money increases, the marginal utility of money decreases no doubt but the rate of decrease is very slow. The point of satiety is never reached. In other words, a situation will never come when marginal utility of money will be zero. Since money represents general purchasing power, an additional unit of money can purchase chocolate of a post-card which has utility, when plotted on a piece of graph paper, the marginal utility curve for money slowly slopes downwards but never touches the X-axis.

Importance of the Law

              The law of diminishing marginal utility has great theoretical and practical significance:

• The law solves the paradox of value. It could explain why water having high use value commands a low price in the market whereas diamond having low use value or utility commands a very high price.

• The law justifies the progressive taxation in a tax system. That means why a rich man should pay at a higher rate of tax than the poor is successfully explained by this law. The rich man’s marginal utility of money is low and that of the poor is high. Hence the rich should pay at a higher rate of taxation than the poor. This will maintain justice in taxation.

• The law of diminishing marginal utility is the basis of the law of demand which states that when price falls, demand rises and vice versa. When we consume an additional unit, its marginal utility falls. Unless price falls, the additional unit will not bring any benefit to the consumer.

• The law also helps us to understand the concept of consumer’s surplus, the surplus satisfaction got by the consumer from a given monetary outlay is called consumer’s surplus. If the marginal utility is a greater than the price paid, the consumer derives surplus satisfaction. The marginal utility of the commodity determines the ‘willingness to pay’ and the price is the ‘actual payment’. The difference between the two is the satisfaction derived which is otherwise called consumer’s surplus.