Published Mar 22, 2024 ### Gossen’s Third Law #### Definition of Gossen’s Third Law Gossen’s Third Law, though less frequently discussed compared to his first two laws, revolves around the idea of the “diminishing marginal utility of money.” It posits that as the wealth of an individual increases, the marginal utility of money to that person decreases. This law extends the concept of diminishing marginal returns from the consumption of a specific good to the general use and value of money itself. #### Example To illustrate this, consider Alice, who earns $20,000 a year. For Alice, an extra $100 represents a significant increase in her disposable income, and she might derive great utility from spending this additional amount on leisure or basic necessities. Now, imagine Bob, who earns $200,000 a year. The same $100 increase in his disposable income is far less significant to Bob than it is to Alice, because it represents a much smaller percentage of his total income. Therefore, the marginal utility of that $100 is much higher for Alice than for Bob. #### Why Gossen’s Third Law Matters Understanding Gossen’s Third Law is crucial for several reasons. Firstly, it has implications for economic policies, particularly those related to taxation and welfare. Progressive taxation systems, where higher income brackets are taxed at higher rates, are partly justified through this principle. The assumption is that taking more money from wealthier individuals (where the marginal utility of money is lower) and redistributing it to less wealthy individuals or investing it in public goods generates a net increase in societal welfare. Furthermore, Gossen’s Third Law also plays a role in consumer behavior, influencing how individuals allocate their resources. It might help explain why wealthier individuals are more inclined to invest their money or spend it on luxury goods, seeking higher returns or greater utility than what the additional money would offer if just added to their wealth. #### Frequently Asked Questions (FAQ) **How does Gossen’s Third Law interact with the concepts of income elasticity and luxury goods?** Gossen’s Third Law interacts with these concepts through the understanding that as individuals become wealthier, their spending patterns shift. Income elasticity refers to how demand for goods changes as income changes. Luxury goods, which have a high income elasticity, become more in demand as wealth increases because the marginal utility of additional consumption (of luxury items) remains high, while the marginal utility of money decreases. **Can Gossen’s Third Law explain economic behaviors in all income brackets?** Yes, to a degree. While Gossen’s Third Law primarily highlights the diminishing marginal utility of money as wealth increases, its principles can be applied across all income brackets to analyze changes in spending habits, savings, and investment behaviors as income varies. **Is there a point at which money’s marginal utility does not decrease with increases in wealth?** Theoretically, the marginal utility of money continues to decrease as wealth increases, but the rate at which it decreases can vary significantly among individuals, depending on their preferences, needs, and the context of their wealth. At extremely high levels of wealth, the marginal utility of additional money may become negligible for practical purposes, though not necessarily reaching zero. Gossen’s exploration of economic behavior through his laws, including the third, underscores the intricate dynamics of value, utility, and human satisfaction within the framework of economic decision-making. By delving into these concepts, one gains a deeper understanding of both individual and collective economic behaviors, enabling more nuanced approaches to both personal finance and public economic policy.
Economics