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AGGREGATE MARKET EQUILIBRIUM: The state of equilibrium that exists in the aggregate market when real aggregate expenditures are equal to real production with no imbalances to induce changes in the price level or real production. In other words, the opposing forces of aggregate demand (the buyers) and aggregate supply (the sellers) exactly offset each other. The four macroeconomic sector (household, business, government, and foreign) buyers purchase all of the real production that they seek at the existing price level and business-sector producers sell all of the real production that they have at the existing price level. The aggregate market equilibrium actually comes in two forms: (1) long-run equilibrium, in which all three aggregated markets (product, financial, and resource) are in equilibrium and (2) short-run equilibrium, in which the product and financial markets are in equilibrium, but the resource markets are not.

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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
Marginal 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 Works

Making 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 Demand

While 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.

<= LAW OF DIMINISHING MARGINAL RETURNSLAW OF INCREASING OPPORTUNITY COST =>


Recommended Citation:

LAW OF DIMINISHING MARGINAL UTILITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: October 25, 2014].


Check Out These Related Terms...

     | marginal utility and demand | marginal utility curve | diamond-water paradox |


Or For A Little Background...

     | marginal utility | total utility | util | utility | consumer demand theory | utility analysis | satisfaction | value | demand | market demand | demand price | law of demand |


And For Further Study...

     | utility maximization | constrained utility maximization | rule of consumer equilibrium | utility measurement | cardinal utility | ordinal utility | utilitarianism | marginal utility-price ratio | income change, utility analysis | price change, utility analysis | preferences change, utility analysis | law of diminishing marginal returns | short-run production analysis |


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