In developing a theory of consumer behaviour, based on the utility gained from the consumption of a good or service, one must begin by considering the consumption of a single unit of a product (Lipsey, Courant and Ragan, 1999:140). In developing the theory, it is important to make a distinction between the consumer’s total utility, which is the full

The Law of Diminishing Marginal Utility

satisfaction resulting from the consumption of that product by a consumer (Lipsey et al, 1999:140), and the consumer’s marginal utility, which is the change in satisfaction resulting from consuming a little more of the product (Lipsey et al, 1999:140).

Consider a consumer buying two goods, X and Y and priced at PX and PY respectively. If PX were three times greater than PY it would represent poor use of money if the marginal utility of the two goods were equal (Nelson and Stackhouse, 2001:215). The consumer would be spending three times more on product X to get equal utility to what could have been acquired by spending three times less on product Y (Nelson and Stackhouse, 2001:215). Imagine that for the consumer the utility of the last unit of currency spent on product X yields three times the utility of the last unit of currency spent on product Y (Nelson and Stackhouse, 2001:215). In this case, the consumer can increase total utility by switching a unit of currency from product Y to product X and by gaining the difference between the utilities of a unit of currency spent on each (Nelson and Stackhouse, 2001:215). The utility-maximising consumer will continue to switch expenditure from product Y to product X as long as the last unit of currency spent on product X yields more utility than that of product Y (Nelson and Stackhouse, 2001:215). This switching, however, reduces the quantity of product Y consumed and given the law of diminishing marginal utility, raises the marginal utility of product Y (Nelson and Stackhouse, 2001:215). At the same time, switching increases the quantity of product X consumed and thereby lowers the marginal utility (Nelson and Stackhouse, 2001:215). From this, the condition required for a consumer to be maximising utility, for any pair of products is:

If this is what each consumer does, it is also what all consumers taken together do (Wheelan, 2002:159). Thus the theory of

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