The Importance of the Law of Diminishing Marginal Utility are given below:
(1) The law of diminishing marginal utility solves the paradox of value:
The concept of diminishing Marginal Utility helped to solve the paradox of value which worried, Adam Smith when he wrote “Wealth of Nation”. This paradox of value is ordinarily referred as Water-Diamond Paradox.
ADVERTISEMENTS:
Adam Smith was perplexed to know why water which is so very essential to life has low or no price and diamond which is an inessential object has high price. This water diamond Paradox he could not solve.
But Marshall with the analysis of Marginal Utility solved this Paradox. The price of commodity is not determined by the total utility but by the marginal utility.
Image Source:2012books.lardbucket.org
According to the law of diminishing marginal utility, the marginal utility of a good decline as the stock of the good increases. The consumer has sufficient stock of water. Therefore the marginal utility of an additional glass of water is very low.
But the marginal utility of on additional piece of diamond is very high. This is the reason why water is available at a low price whereas diamond commands a very high price in the market. Since water is scarce in a desert, it would command a very high price than diamond and its marginal utility is very high in the desert.
(2) The law is of great use to the finance minister of a country:
ADVERTISEMENTS:
The finance minister of a country taxes the rich at a proportionately higher rate and poor people at a lower rate. This is called the system of progressive taxation. The Govt. takes away the money from those who have got less marginal utility and transfer it to those who have got more marginal utility of money.
(3) It forms the basis of all other laws of consumption:
The law of equi-marginal utility by which a consumer can maximise his satisfaction, is based on the concept of diminishing utility. The concept of consumer surplus is also based on this-law of consumption i.e., the Jaw of demand holds good.
(4) Useful to socialism:
The law is useful to socialism. Because socialists take their stand on this law when they advocate a more equal distribution of wealth.