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Unit III Utility Analysis Economics
Unit III Utility Analysis Economics
UTILITY ANALYSIS
Introduction:
A consumer demands a good or a service. He demands a good because it gives him
utility. Wants – satisfying capacity of a good is called utility.
Meaning of Utility:
The term utility in economics is used to denote that quality in a commodity or service by
virtue of which our wants are satisfied. In other words, want – satisfying power of a good
is called utility.
Definitions:
According to Jevons, “Utility refers to abstract quality whereby an object serves
our purpose.
In the words of Hibdon, “Utility is the quality of good to satisfy a want.”
According to Mrs. Robinson, “Utility is the quality in commodities that makes
individuals wants to buy them”.
Features:
1. Utility is Subjective: as it deals with the mental satisfaction of a man. A thing may
have different utility to different persons. E.g. Liquor has utility for drunkard but for
person who is teetotaller, it has no utility.
2. Utility is Relative: As a utility of a commodity never remains the same. It varies with
time and place. E.g. Cooler has utility in summer not during winter season.
3. Utility is not essentially Useful: A commodity having utility need not be useful. E.g.
Liquor and cigarette are not useful, but if these things satisfy the want of addict then
they have utility for him.
Concepts of Utility:
1) Initial Utility: The utility derived from the first unit of commodity is called initial
utility. It is obtained from the consumption of the first unit of a commodity. It is
always positive.
2) Total Utility: The aggregate of utility obtained from the consumption of different
units of a commodity, is called Total utility.
Tux = f (Qx)
Tux = total utility of x is a function (f) of quantity of commodity x.
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3) Marginal Utility: The change that takes place in the total utility by the consumption
of an additional unit of commodity is called marginal utility.
TU = MU
Table:
Quantity Total Marginal Description
Utility Utility
0 0 - Initial Utility
1 8 8–0=8
2 14 14 – 8 = 6 Positive Utility
3 18 18 – 14 = 4
4 20 20 – 18 = 2
5 20 20 – 20 = 0 Zero Utility
6 18 18 – 20 = -2 Negative Utility
a) As more and more units of commodity is consumed, the marginal utility derived
from each successive unit goes on diminishing. But the total utility increases up to
a limit.
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b) Marginal utility of the first four units being positive, the total utility goes on
increasing. Thus as long as the marginal utility of the commodity remains
positive, total utility goes on increasing.
c) Marginal utility of the fifth unit is zero. In this situation total utility (20) will be
maximum. This situation also represents point of saturation.
d) Marginal utility of the sixth unit is negative. As a result of it, total utility of six
units of the commodity falls from 20 to 18 units.
Figure A
TU represents Total utility
It slopes upwards upto point F means TU is
rising upto the consumption of 4 unit.
From point F to G TU is constant
Point G represents maximum total utility.
After point G, TU slopes downwards,
meaning there by utility becomes negative
and total utility begins to fall.
O X
Figure B
Marginal Utility Curve MU represents Marginal Utility
[B]
It slopes downwards from left to right; MU
Y
of successive units goes on diminishing.
Upto fourth unit of commodity, MU goes
on diminishing but TU goes on increasing.
At the fifth unit MU curve touches OX –
axis, MU utility is zero and TU is
maximum.
After fifth unit MU curve intersects Ox –
axis and slopes downward. Means that
sixth unit yields negative MU. And TU
begins to diminish.
O X
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Can utility be measured?
It can be attempted to measure by two methods:
2. Measurement in terms of Units: Prof. Fisher has used the term, “Util”, as a unit for
the measurement of utility. In this method utility is expressed in Utils.
Law of Diminishing Marginal Utility is the foundation stone of utility analysis. All of us
experience this law in our daily life. If you buy pen at any given time, then as the number
with you is increasing, the marginal utility from each successive pen will go on
decreasing. It is the reality of man’s life which is referred to in economics as Law of
Diminishing Marginal Utility.
Definitions:
According to Marshall, “The additional benefit which a person derives from a
given stock of a thing diminishes with every increase in the stock that he already
has.”
It is clear from the above definitions that at a given time when we go on consuming
additional units of a commodity, the marginal utility from each successive unit of that
commodity, other things being equal, goes on diminishing in relation to the preceding
unit. It is this diminishing tendency of the marginal utility that has been enshrined in the
law of diminishing marginal utility.
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Assumptions:
1. Utility can be measured in the Cardinal number system.
2. Marginal Utility of money remains constant.
3. Marginal Utility of every commodity is independent.
4. Every unit of the commodity being used is of same quality and size.
5. There is a continuous consumption of commodity
6. Suitable quantity of a commodity is consumed.
7. There is no change in the income of consumer.
8. There is no change in the price of commodity and its substitutes.
9. There is no change in the tastes, character, fashion, and habits of consumer.
Explanation:
The law can be explained with the help of the table and figure below:
Table
No. of Ice Cream Cups Marginal Utility Table Shows:
First 4 The table shows that first cup of ice cream
yields 4utils of marginal utility.
Second 3
Third 2 The second cup of ice cream will yield less
marginal utility than the first one i.e. 3utils.
Fourth 1
Fifth 0 Third cup will yield still less MU, say
2utils.
Sixth -1
Fourth cup will yield just 1utils of MU. At
this stage want may be fully satisfied.
Y A Thus fifth cup will yield zero MU. If you
are forced to take sixth cup of ice cream it
4 +Ve may upset system and yields negative
utility say, -1 util.
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In the Figure:
Point of Saturation OX axis – Ice Cream(Quantity)
2 OY axis – Marginal Utility(MU)
AB is Marginal Utility Curve (MUC)
It slopes downward from left to right
1 (negative slope) indicating first cup
Zero MU of ice cream 4 utils, second 3 utils,
C third 2 utils and fourth 1util of
O X marginal utility. Fifth cup of ice –
1 2 3 4 5 6 cream yields zero marginal utility.
AB curve touches OX – axis at point
-1 B C that represents fifth cup of ice
cream.
sixth cup of ice cream yields negative
marginal utility and so AB curve goes
below OX – axis.
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Exceptions:
Law does not apply under the following situations:
1. Curious and rare things Law does not apply to rare or curious things like
persons who collect old and rare coins, postage stamps as increasing marginal
utility as the stock of these rare articles goes on increasing. They are always keen
to obtain more and more units of such things.
2. Misers It seems law does not apply to misers who are out to acquire more and
more of wealth. Their desire for money seems to be insatiable.
4. Drunkards It can be said that when a drunkard takes a liquor and intoxicant than
as he takes more and more pegs of liquor his desire to have more of it goes on
increasing.
5. Initial units When the initial units of a commodity in used in less then
appropriate quantity, then the marginal utility from the additional units goes on
increasing.
In short, Prof Taussig has rightly said that the tendency of law of diminishing marginal
utility is so widely relevant that it would not be wrong to call it as universal law.
3. Alternative uses Each commodity has many alternative uses. Some uses are more
important while others are less. Example every consumer gives first priority to the
most important use. If we have to give little quantity of milk, it will be used for
feeding the infant only, but if we have large quantity of milk then after feeding the
infant rest can be used for making tea for elders or for making curd etc.
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satisfaction the consumers spends his income in such a way that the last
unit of money spent on different commodities yield equal marginal utility.
b) Law of demand According to this law a consumer will demand more
units of a commodity at low price.
c) Concept of consumer surplus According to this concept unit prior to the
marginal unity yield more utility. This surplus utility is called consumer
surplus.
Derivation of demand curve with the help of law of diminishing marginal utility:
The price that consumer pays for a commodity is equal to its Marginal utility. According
to law of diminishing marginal utility, as a consumer goes on purchasing more and more
units of a commodity its marginal utility goes on diminishing. As such consumer will buy
more units of commodity only when its price goes down. When marginal utility is
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expressed in terms of money, in that case, positive part of marginal utility curve will be
the demand curve.
Y [A] Y [B]
M D
Diminishing MU
M1 P1 Demand Curve
Price
M2 P2
M3 P3
O Q1 Q2 Q3 U X O Q1 Q2 Q3 X
Quantity Quantity
When marginal utility is shown on OY – axis then the curve obtained will be marginal
utility curve. In case, price is shown on OX – axis then the curve obtained will be called
demand curve as is indicated in figure above. Figure A represents marginal utility curve.
Figure B represents demand curve. This DD demand curve has been drawn with the help
of marginal utility curve.(MU)
Criticism:
1. Cardinal measurement of utility is not possible. The assumption of the law that
marginal utility can be measured in cardinal numbers is not correct. In the
absence of cardinal measurement one cannot calculate diminishing marginal
utility.
2. Marginal utility of money is not constant. According to this law money is taken
as the measure of utility. But the marginal utility of money itself never remains
constant as money cannot be reliable.
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LAW OF EQUI – MARGINAL UTILITY
Law of equi – marginal utility is the second important law of utility analysis. This law
point out of how a consumer can get maximum satisfaction out of his given expenditure
on different goods. This law concerning the expenditure of the consumer was propounded
in 19th century by a French engineer Gossen.
Dr Marshall has called it law of Equi Marginal Utility. It states that in order to get
maximum satisfaction, consumer should spend his limited income on different
commodities in such a way that the last rupee spent on each commodity yield him equal
marginal utility.
Left witch refer to it as the general principal for maximization of consumer satisfaction.
In simple words it is called as law of maximum satisfaction.
Definitions:
According to Dr. Marshall, “If a person has a thing which he can put to several
uses, he will distribute it among these uses in such a way that it has the same
marginal utility in all.”
According to Prof. Lipsey “The household maximizing utility will so allocate its
expenditure between commodities that the last penny spent on each is equal.”
If the prices of the commodities are equal, then maximum satisfaction to the
consumer can be indicated in the following equation:
In the above equation MU1, MU2, MU3 refers to marginal utility of the first,
second, third commodity and P1, P2, P3 refers to the price of all commodity.
Assumptions:
1. Cardinal measurement of utility is possible.
2. Consumer is rational that he wants maximum satisfaction from his income.
3. Income of consumer is constant.
4. Marginal utility of money remains constant.
5. Price of the commodity remains constant.
6. Commodity is divisible into small units.
7. The consumption takes place at a given period of time.
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Explanation:
The law can be explained with the help of table and figure below:
Table
Rupee Spent MU of MU of Milk
Mangoes
1st 12 10
2nd 10 8
3rd 8 6
4th 6 4
5th 4 2
Y MU of Mangoes Y MU of Milk
[A] [B]
12 12
8 Utility 8
6 6
4 4`
O 1 2 3 4 5 X O 1 2 3 4 5 X
10
Y MU of Mangoes Y MU of Milk
12 12
10 10 E
8 A 8 F
6 B 6
4 Gain 4 Loss
D C H G
O 1 2 3 4 5 X O 1 2 3 4 5 X
Rupees Rupees
If the consumer spends his income on mangoes a milk in any other manner,
then his total utility will be less than the maximum; as in figure above.
OX axis – Rupees OY axis – M. Utility
It is evident from the figure that by spending one rupee on mangoes the
consumer gains 6utils of marginal utility as shown by ABCD area.
Similarly by spending one rupee less on milk, the consumer loses 8utils of
marginal utility as shown by EFGH area.
3. Exchange It implies replacing of goods giving less utility with goods giving more
utility. Acting upon the law every person will go on substituting goods giving more
utility for the ones giving less utility, till the marginal utility of all becomes equal.
5. Public finance The law also has importance in this sphere of public finance, that
revenue and expenditure of the sate. It is insured that the marginal benefit of every
type of expenditure should be equal.
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money spent on present consumption should yield the same utility as the last unit of
money kept in the form of saving. Such a distribution is called optimum allocation.
8. Distribution of assets: This law helps people distribute their assets in different
forms like bank deposits, bonds, stock, share etc. According to this law, investment
should be made in different form of assets in such a way that last unit of money
invested in each form should yield equal marginal utility.
3. Shortage of goods If goods giving more utility are not available in the
market, the consumption will have to consume goods yielding less utility.
6. Indivisibility of Goods The law does not apply to those goods which can
not be divided into small parts e.g. Car, LCD etc.
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8. Indefinite Budget period The budget period of consumer is not definite.
Budget periods refer to that period in which a consumer has to spend his income of
different uses. It may be a month or an year. Goods like TV Set, Refrigerator are
bought in one budget period, but they continue to yield utility over many budget
periods.
10. Change in the marginal utility of money In actual life marginal utility of
money may increase or decrease. When a consumer buys more goods, he is left with
less amount of money. Smaller the amount of money higher is its marginal utility. As
a result of it application of the law will become pretty difficult.
11. Complementary goods The law does not apply to complimentary goods
because they are used in fixed proportion. By using less of one commodity, use of
other can not be increased.
In short, Chapman has rightly said about this law, “We are not, of course, compel to
distribute our income according to the law of substitution or Equi-marginal expenditure,
as a stone thrown in the air is compelled, in a sense to fall back to the earth but as a
matter of fact, we do so in a certain rough fashion because we are reasonable”.
5. Marginal utility of money does not remain constant. As the quantity of money
with a person increases, its marginal utility diminishes and as the quantity of
money decreases, its marginal utility increases.
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6. Too many assumptions. Practicability of any theory depends on its practical
assumptions. Many assumptions like Cardinal number system, independent
commodities etc. are unrealistic and impracticable.
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