Question

A basic feature of the utility function (demand curve) is the law of diminishing marginal utility. That is, as a person consumes an item or a product, the satisfaction or utility that they derive from the product wanes as they consume more and more of that product. In other words, the price a person is willing to pay (or the demand) for that product decreases with consumption. However, our demand for some environmental goods (e.g., clean air/water) does not wane with quantity.

Does this mean utility function theory does not apply to environmental goods? If it applies, how would you use the utility function theory to explain the supply of and demand for clean air/water?

(Hint: Although the law of DMU may not directly applies to clean air/water, it affects other goods that we consume. And given the scarcity of resources, e.g., the total amount of money that we can use, we may have to choose between clean air and some other goods. For example, many people have to work in an environment with poor air quality. )

Answer 1

                                    The Law of diminishing marginal utility states that with all other facts remaining constant in an economy, the marginal utility derived from each additional unit in an economy decreases with the increase in the consumption of that particular commodity. This means that as the propensity to consume increases, the derived utility would start to decline in an economy. Thus, in the longer course of consumption of an individual commodity, the marginal utility of that particular commodity is expected to turn in to a negative utility which would finally cause a reduction in the production capacity of that particular unit.

                                    As the utility of the product declines, the consumption would decline and thus the consumers would now pay lesser money to buy the same quantity of products in such a market. The given case talks about the application of this utility theory to environmental goods and states that the theory does not fix in to it. In this context, it has to be discussed about the environmental goods and how it is being consumed in an economy. Environmental goods like air, water etc falls in to the category of social goods or public goods for which no pricing is being made by those who consumes it. Moreover, nobody would be restricted from its consumption and the quantity that could be consumed is also not specified in an economy.

                                    The environmental goods fall in to a category of essential goods also and thus it has to be noted that these goods would have to be consumed for the sustenance of life and hence nobody could apply the theory of law of diminishing margin in to it. Once the decline in the consumption of these goods occurs, it would lead to health matters and the sustenance of life in general. Moreover, they are available in abundance and hence they could be consumed. The difference is that the efficiency in delivery would differ as suggested since many would be forced to consume lower quality of air and water in accordance with the environmental conditions of that place. But at those situations, the marginal utility would not decline, rather there would be increased competition to consume good quality of those in such an economy, but the marginal utility of consumption of bad quality environmental goods would see a decline in such an environment. Thus, it can be also used to explain the supply of and demand for clean air and water. As the availability of fresh air and water declines in an environment, such an economy would see a rise in the demand for such commodities which would set new parameters for its consumption and thus causes a rise in the consumption expenditure for such commodities in the economy. Thus, an increased demand would not be able to increase the supply in this case as it cannot be created like any other commodity. Thus, an increased demand would set limits for its consumption which would force certain consumers to decrease their consumption and hence would cause a diminishing utility.