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TAX MULTIPLIER: The ratio of the change in aggregate output (or gross domestic product) to an autonomous change in a taxes. The tax multiplier is equal to the expenditure multiplier times the marginal propensity to consume. This is based on the only a fraction of the change in disposable income resulting from the change in taxes will result in a change in consumption expenditures. The tax multiplier can be used to indicate the change in fiscal policy induced government taxes are needed to achieve a given level of aggregate output (presumably full-employment output).
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                           LAW OF DIMINISHING MARGINAL UTILITY: A principle stating that as the quantity of a good consumed increases, eventually each additional unit of the good provides less additional utility--that is, marginal utility decreases. Each subsequent unit of a good is valued less than the previous one. The law of diminishing marginal utility helps to explain the negative slope of the demand curve and the law of demand. The law of diminishing marginal utility means that the value of a good, the extra utility derived from a good, declines as more of the good is consumed. This has a direct bearing on the market demand, the demand price, and the law of demand. If the satisfaction obtained from a good declines, then buyers are willing to pay a lower price, hence demand price is inversely related to quantity demanded, which is the law of demand.A Few Numbers| Roller Coaster Utility |  |
To illustrate this highly useful law, take a gander at the table presented to the right. The story behind the table is this: Edgar Millbottom, Shady Valley's most devoted roller coaster devotee, has spent the day riding the Monster Loop Death Plunge roller coaster at the Shady Valley Amusement Park. After each ride, he is hooked up to a hypothetical "utilnometer" to measure his total utility from all rides, and most important to this discussion, his marginal utility from each additional ride.As such, Edgar's first ride generates an extra 11 utils of satisfaction, the second ride provides an extra 9 utils, the third ride comes in with an extra 7 utils, and so forth. The declining marginal utility numbers--11, 9, 7, etc.--illustrate the law of diminishing marginal utility. Each additional ride generates less extra utility than the previous one. In fact, marginal utility continues to decline until the seventh and eighth rides generate negative marginal utilities. Edgar is less satisfied, in total, after 7 rides than after 6 rides. Why it WorksMaking up a few hypothetical numbers about a hypothetical person who spends a day riding a hypothetical roller coaster is not a big challenge. Fabricating a series of numbers that illustrate diminishing marginal utility is relatively easy. However, the ease of such hypothetical fabrication, does not make it true. In other words, how and why does the law of diminishing marginal utility work? What is the logic behind this law?The key terms needed for a behind-the-scenes understanding of this law are satisfaction and fulfillment. When Edgar first enters the Shady Valley Amusement Park, he has ridden no roller coasters. His want (or need) for riding roller coasters is totally unfulfilled. He is like an empty vessel waiting to be filled with the excitement of the Monster Loop Death Plunge roller coaster. The first ride partially fills Edgar's roller coaster void, but not completely. The second ride, then fills the void a little more. But here is the key. When Edgar takes his second ride he already has taken ONE roller coaster ride. He already has received the initial jolt of excitement from the FIRST ride. The second ride is not as exciting as the first. Edgar's roller coaster want (or need) has already been partially satisfied, meaning less remains to be satisfied. Eventually, with the sixth ride, Edgar's roller coaster want (or need) has been totally satiated. He is completely fulfilled--roller coaster-wise. This, in fact, is why the seventh and eighth rides have negative marginal utilities. They actually detract from the overall roller coaster experience. The Law of DemandWhile the law of diminishing marginal utility pops up throughout the study of economics, it is most important to the study of demand and the law of demand. It offers preliminary insight into the age-old question: "Why does the demand curve have a negative slope?"The key to this connection is that the demand price that a buyer is willing and able to pay for a good depends on the satisfaction (utility) generated from consumption. A buyer is willing to pay a higher demand price if utility is greater or a lower demand price if utility is less. Because marginal utility diminishes as the quantity of a good is consumed increases (the law of diminishing marginal utility), buyers are willing and able to pay lower prices for larger quantities (the law of demand). Hence, the law of demand exists because the less satisfaction is received for larger quantities. This law of diminishing marginal utility is the counterpart of the law of diminishing marginal returns. As the law of diminishing marginal utility offers an explanation for the law of demand and the negative slope of the demand curve, the law of diminishing marginal returns offers an explanation for the law of supply and the positive slope of the supply curve.
Recommended Citation:LAW OF DIMINISHING MARGINAL UTILITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: April 27, 2024].
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