What Is the Relationship Between the Law of Diminishing Marginal Utility & Consumer Surplus?

George Doyle/Stockbyte/Getty Images

There's a lot more to being a business manager (or owner) than knowledge of a specific industry. Understanding economic principles can be essential to business managers regardless of what a company actually does. Consumer surplus and diminishing marginal utility are economic concepts related to the benefit consumers get when buying products and services.

Consumer Surplus

Consumer surplus is the difference between the amount you are willing to pay for a product or service and its price. For example, if you like ice cream, you might be willing to pay $7 for a cone at your favorite ice cream shop. If the shop charges $4 per cone, buying one results in a $3 consumer surplus. Consumer surplus is essentially the dollar value of the benefit or utility you gain when you buy something.

Diminishing Marginal Utility

The law of diminishing marginal utility is an economic concept that states that the benefit you gain from consuming something eventually gets smaller and smaller as you consume more of it. For instance, you might derive a lot of satisfaction from eating one ice cream cone, but you'll likely get less utility out of eating a second or third cone. Diminishing marginal utility illustrates why it's possible to have too much of a good thing.

Law of Diminishing Returns and Surplus

Diminishing marginal utility causes consumer surplus to fall as you purchase more of the same thing. Buying a single ice cream cone might give you a surplus of $3, but after consuming it, the law of diminishing returns that you won’t be willing to pay as much for the another one. If your willingness to pay falls by $2, you'd only derive a surplus of $1 when buying a second cone. As you buy more of the same item, consumer surplus eventually drops to zero, at which point you don't buy any more.

Business Implications

Consumer surplus and diminishing marginal utility can help business managers understand why customers make the choices they do and set prices to maximize returns. For instance, if consumers derive a large surplus from buying a particular product, the business that sells it might be able to increase the price of the item without losing many sales -- with the result being a boost in profit.