The Law of Diminishing Marginal Returns and Affluence

The Law of Diminishing Marginal Returns says that as people use more of a product or service, the satisfaction they get from each additional purchase declines. This is used to explain why demand for a product goes down as the price goes up. At a high price, I may be willing to buy a product once, but my return (satisfaction) from a repeat purchase will be too small to make me willing to pay that high price a second time. If I paid $30 for a steak dinner, I’m unlikely to order another even if I’m still hungry. However, at a lower price, the return from a repeat purchase will still be great enough to make a second or even a third purchase worth it. If I’ve only paid $4 for a Big Mac value meal, if I’m still hungry I might just go through the drive through again. So, across a whole economy, there will be many more Big Macs sold than steak dinners. Makes sense.

Clearly, this theory is meant to apply to repeat purchases of a single item, or at least purchases within a class of items that are roughly comparable. And, presumably, choices made in one sphere of consumption – say fast food consumption – would not be expected to grossly effect choices made in another sphere of consumption – say entertainment electronics. The number of Big Macs I ate today, and the diminishing marginal returns that I got for each additional Big Mac, should not have much of an effect on my willingness to pay for a big screen TV.

Or does it? If we consider categories of consumption that are different but not as different as fast food consumption versus entertainment electronics, there in fact may be a relationship. Let’s take clothing consumption and gift item consumption (by which I mean all those commemorative knick-knacks languishing in the dark corners of closets across America). Now, on immediate consideration, my demand for t-shirts would seem to be fairly independent from my demand for piña colada scented candles. But both t-shirts and piña colada scented candles are things that people buy in malls or other shopping venues where they go to shop for entertainment. And when people “go shopping” for entertainment, they usually aren’t searching for particular items, or even classes of items. What they are consuming is in large part the experience of consuming—an entertainment “service” of sorts which comes with “goods” as a bonus. What we have then is that consumption of consumer goods has a return (a level of satisfaction) above and beyond the value of the good itself—the entertainment return.

That entertainment return must be subject to the eternal law of diminishing returns, right? If I have already been shopping for most of the day and I have spent $200 on clothing, I am going to be much less likely to go into that gift store, spend a half an hour more on my feet, just to spend $15 more on that adorable little porcelain kitten for Grandma. Now the value of the good may not have changed. That porcelain kitten may be just as perfect for Grandma now as it was this morning when I entered the mall. And I may be just as willing to spend $15 on Grandma’s happiness now as I was this morning. What has diminished is the return I’m getting from the service of the shopping mall—the shopping entertainment experience. I’ve already spent $200 for the previous six hours of the shopping entertainment experience, and I don’t really want to spend $15 for an additional half an hour of porcelain knick-knack browsing bliss.

This example shows how the Law of Diminishing Marginal Returns could, in fact, apply not just to a particular item being purchased at one particular time, but could apply to overall household consumption across time. Theoretically, a household could reach a point where additional consumer goods could potentially bring satisfaction, but the diminishing marginal returns of the experience of acquiring them, storing them, cleaning them, insuring them, fixing them, building a bigger house to hold them…. starts to eat away at demand. Could it be that the spiritual ills of materialism and “affluenza” are built right into the fundamental laws of supply and demand? What does this mean, then, for an economy that is built on ever further and faster growth, which is built on ever more extensive and extravagant consumer spending?

Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007.