Diminishing marginal utility and consumer surplus in marketplace valuation

¶ … Diminishing Marginal Utility is the basis by which a good gets its value in the marketplace? As part of your answer explain the concepts of consumer's preference and consumer's surplus and how they contribute to the valuation process.

The concept of diminishing marginal utility holds that the more a consumer consumes something, the less he or she will gain in terms of his or her real and perceived value of that good, from adding additional units of that good to his or her market basket. For example, by offering a discount for every next doughnut purchased at a coffee shop, the owner creates an incentive for a consumer to buy two, rather than one doughnut, thus raising the overall volume of sales. However, if the consumer gains a discount for every additional doughnut, not just the second doughnut, the discount on the third doughnut will not be as important to the consumer as the discount on the second doughnut, as the third doughnut has lost its value to some extent -- presumably the consumer's desire for doughnuts as been somewhat satiated, and the funds used to purchase additional pastries could be put to better use for other goods produced during the consumer's day.

The concept of consumer preference holds that consumers will always wish to have more for less money. Thus, all things being relatively equal a basket with more is more desirable than one with fewer goods for the same price. Or, to take another, real world example, the popularity of supersizing a fast food meal, getting considerably more cola and French fries for what amounts to virtual pocket change, is an incentive to buy the larger meal. Consumer surplus is the difference between what a consumer is willing to pay vs. what he or she must pay. A consumer may feel that he or she is getting a wonderful bargain on the Extra Value meal, because he or she desires more French fries and would pay even more for this tasty treat than a few cents. This is despite the fact that the cost to the franchise for the excess cheap fried vegetables and syrup for the huge soda is almost nothing.

The shape of the short run variable cost curves is based upon the underlying notion of the Law of Diminishing Returns. Explain why for most industries, this law must eventually come into play.

The Law of Diminishing Returns holds that as one produces more and more of a desirable good, one must divert more and more of the labor force into producing that good. Human labor and labor costs are finite. Thus, a farm responding to a sudden surge in demand, for say, potatoes (because of the sudden and unexpected popularity of the Extra Value meals of Discussion Question 1) must divert human labor away from toiling the tomato and lettuce fields on the same farm, thus driving up the cost of these products. For most industries, which produce more than one good, the law will eventually come into play. A producer must always remember that when one factor of production is increased, such as labor costs, or the material costs needed to operate a factory to shred potatoes into fries, etcetera, while the others remain constant, the overall returns for increasing the supply and profits will relatively decrease after a certain point. Even if more and more laborers are added to harvest ever-more desirable potatoes, at some point each additional laborer will be able to harvest fewer potatoes than the original labor force as he or she has less land to till, and thus will produce relatively less output from the smaller plot of land.