GOSSEN'S LAWS: EXPLANATION WITH EXAMPLES - ECONOMY - 2024

The laws of Gossen, created by the German economist Hermann Gossen (1810-1858), are three important laws of economics related to the diminishing marginal utility, the marginal cost of acquisition and scarcity.

Gossen was the first to explain the law of diminishing marginal utility, or Gossen's first law, based on general observations of human behavior. This law affirms that the amount of the same enjoyment decreases continuously as one advances without interruption in that enjoyment, until satisfaction is achieved.

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The second law, the equi-marginal utility law, explains consumer behavior when he has limited resources, but unlimited wants.

The fundamental problem in an economy is that human wants are unlimited, but there are not adequate resources to satisfy all human wants. Therefore, a rational individual tries to optimize the scarce resources available to achieve maximum satisfaction.

The third law refers to the economic value of products, which results from a previous shortage.

Gossen strove to find each of these laws in all kinds of economic activities.

Gossen's First Law

It is known as the law of diminishing marginal utility. It states that when an individual consumes more than one product, total utility increases at a decreasing rate.

However, after a certain stage, the total utility also begins to decrease and the marginal utility becomes negative. This means that the individual no longer needs the product.

That is, an individual's desire for a particular product becomes saturated when he consumes it more and more.

Example

Suppose you are hungry and have some oranges. Eating the first orange provides a great deal of utility. The marginal utility of the second orange is certainly less than that of the first.

Similarly, the marginal utility of the third orange is less than that of the second, and so on.

After a certain stage, marginal utility becomes zero and beyond this stage, it becomes negative. This is because it becomes satiated as more and more oranges are consumed.

To understand it better, you can see table 1. The figures are hypothetical and represent the marginal utility of consuming oranges for one person.

Total profit

The total utility is obtained by adding the marginal utility of each consumed unit of orange. According to Table 1, the total utility of the first six oranges is 21 (21 = 6 + 5 + 4 + 3 + 2 + 1).

Marginal utility

The marginal utility of the n-th unit of the product is the difference between the total utility of the n-th unit and the total utility of the (n-1) -th unit of the product. UMn = UTn - UT (n-1) where, MUn = marginal utility of the nth unit.

UTn = Total utility of the nth unit.

UT (n-1) = Total profit of the unit (n-1) -th.

In the example in Table 1, the marginal utility of the fourth orange is CU4 = TU4-TU3 = 18-15 = 3.

The following figure details the trajectories of the total utility and marginal utility curves.

The total utility curve initially increases and, after a certain stage, begins to decrease. It is at this stage that the marginal utility curve enters the negative zone.

Gossen's second law

The second law says that each person will spend their money on different products, so that the amount of all pleasures is equal.

In this way, Gossen explained that maximum enjoyment would be achieved from a uniform level of satisfaction. Gossen's second law is known as the law of equi-marginal utility.

Suppose a person owns $ 200. The law explains how the person allocates the $ 200 between their different wishes to maximize their satisfaction.

The point at which consumer satisfaction is highest with the given resources is known as consumer equilibrium.

Example

Suppose there are two products X and Y. The consumer's resource is $ 8. The unit price of product X is $ 1. The unit price of product Y is $ 1.

The consumer spends his $ 8 buying product X. Since the unit price of product X is $ 1, he can buy 8 units.

Table 2 shows the marginal utility of each unit of product X. Since the law is based on the concept of decreasing marginal utility, it decreases with each subsequent unit.

Now consider that the consumer spends his $ 8 buying product Y. Table 3 shows the marginal utility of each unit of product Y.

If the consumer plans to allocate his $ 8 between product X and Y, Table 4 shows how the consumer spends his income on both products.

Application of the second law

Since the first unit of product X gives the highest profit (20), it spends the first dollar on X. The second dollar also goes to product X, since it gives 18, the second highest.

Both the first unit of product Y and the third unit of product X offer the same amount of profit. The consumer prefers to buy product Y, because they have already spent two dollars on product X.

Similarly, the fourth dollar is spent on X, the fifth dollar on Y, the sixth dollar on X, the seventh dollar on Y, and the eighth dollar on X.

Thus, the consumer buys 5 units of product X and 3 units of product Y. That is, 5 units of product X and 3 units of product Y leave him with the best amount of total utility.

According to the equi-marginal utility law, the consumer is in equilibrium at this point, experiencing maximum satisfaction. To understand this, the total utility of the products consumed can be calculated.

Total profit = UTx + UTy = (20 + 18 + 16 + 14 + 12) + (16 + 14 + 12) = 122. Any other combination of products would leave the customer with a lower total profit.

Gossen's third law

This law indicates that scarcity is a necessary precondition for economic value to exist. That is, a product has value only when its demand exceeds its supply.

Using Gossen's logic, since marginal utility decreases with consumption, a product can only have positive marginal utility or "value" if the available supply is less than that needed to generate satiety. Otherwise, the desire will be satiated and, therefore, its value will be zero.

Gossen's arguments about value are based on the two previous laws. According to him, value is a relative term. It depends on the relationship between the object and the subject.

As the quantity increases, the value of each unit added decreases, until it becomes zero.

References

1. Kirti Shailes (2018). Gossen's First and Second Law of Human Enjoyment. Economics Discussion. Taken from: economicsdiscussion.net.
2. Sundaram Ponnusamy (2014). The Law of Diminishing Marginal Utility or Gossen's First Law. Owlcation. Taken from: owlcation.com.
3. Sundaram Ponnusamy (2016). The Law of Equi-Marginal Utility or Gossen's Second Law. Owlcation. Taken from: owlcation.com.
4. Economics Concepts (2015). Law of Diminishing Marginal Utility. Taken from: economicsconcepts.com.
5. Wikipedia, the free encyclopedia (2018). Gossen's laws. Taken from: en.wikipedia.org.