Utility

“Utility is the quality in commodities that makes individuals wants to buy them”

Mrs. Robinson1

"Utility refers to abstract quality whereby an object serves our purpose."

Jevons

'Utility' has been the central concept in economics for a long time; it is roughly synonymous with
'satisfaction,' 'well-being,' 'welfare,' 'happiness,' 'pleasure,' etc. Generally, we can increase our
utility by undertaking enjoyable activities or purchasing things we desire. In modern economic
theory, this is not the common way the utility concept is introduced. Nowadays the preference
ordering is taken as a primitive term. If two individuals express the same preference in each
conceivable decision situation, their preference orderings are identical. If, however, given a
choice between going to a soccer game and attending a concert of classical music, one individual
chooses the soccer game and the other one prefers the concert, then their preference orderings are
different.2 One would expect that, in making decisions, an individual will try to enhance his
utility. Utility is a somewhat abstract concept. What you buy/consume depends partly upon your
preferences/tastes (and also on resource constraints). If I express a preference for a soccer game
over a classical concert, then it seems reasonable to infer that my utility will be higher when I
visit the game than when I attend the concert. In economic theory, such a perverse relationship
between utility and preference cannot occur, because 'utility' is defined such that a preferred
alternative always represents a higher utility level (or at least not a lower one) than the rejected
alternative. 'Utility' is no longer a primitive term, but it is defined in terms of preferences . 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. 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.

1
Business Economics by Neha Shivani
2
https://core.ac.uk/download/pdf/6560294.pdf
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
teetotaler, 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.

4. Utility is independent of Morality: it has nothing to do with morality. Use of opium liquor may
not be proper from moral point of view, but as these intoxicants satisfy wants of the opium –
eaters, drunkards, they have utility.

Types of utility:

1. Form Utility:
This utility is created by changing the form or shape of the materials. For example—A cabinet
turned out from steel furniture made of wood and so on. Basically, from utility is created by the
manufacturing of goods.

2. Place Utility:
This utility is created by transporting goods from one place to another. Thus, in marketing goods
from the factory to the market place, place utility is created. Similarly, when food-grains are
shifted from farms to the city market by the grain merchants, place utility is created.

Transport services are basically involved in the creation of place utility. In retail trade or
distribution services too, place utility is created. Similarly, fisheries and mining also imply the
creation of place utility. Place utility of a commodity is always more in an area of scarcity than
in an area of scarcity than in an area of abundance e.g., Kashmir apples are more popular and
fetch higher prices in Pune than in Srinagar on account of such place utility

3. Time Utility:
Storing, hoarding and preserving certain goods over a period of time may lead to the creation of
time utility for such goods e.g., by hoarding or storing food-grains at the time of a bumper
harvest and releasing their stocks for sale at the time of scarcity, traders derive the advantage of
time utility and thereby fetch higher prices for food-grains. Utility of a commodity is always
more at the time of scarcity. Trading essentially involves the creation of time utility.

4. Service Utility:
This utility is created in rendering personal services to the customers by various professionals,
such as lawyers, doctors, teachers, bankers, actors etc.3

There is difference between utility and usefulness. A useful commodity may not here utility of
goods depend upon the intensity of wants. A consumer buys or demands a particular commodity
he derives some benefit from its use. He feels that his given want is satisfied by the use or
consumption of the commodity purchased. Utility is the basis of consumer demand. A consumer
thinks about his demand for a commodity on the basis of utility derived from the commodity.
Utility depends upon the intensity of want. When a want is unsatisfied or more intense, there is a
greater urge to demand a particular commodity which satisfies a given want. In modern time
utility has been called as ‘expected satisfaction.’ Expected satisfaction may be less or equal to or
more than the real satisfaction.4 The utility in economics is measured by ‘Utils’ even if it is not
possible to measure someone’s satisfaction or utility of the products he consumes, utils is a term
used for measurement hypothetically.

3
Business Economics by Neha Shivani
4
http://www.economicsdiscussion.net/utility/utility-meaning-characteristics-and-types-economics/13594
 Ordinal and Cardinal Utility

The measurement of utility has always been a controversial issue. Neo-classical economists, such
as Alfred Marshall, Leon Walrus, and Carl Meneger believed that utility is cardinal or
quantitative like other mathematical variables, such as height, weight, velocity, air pressure, and
temperature. Therefore, these economists developed cardinal utility concept to measure the
utility derived from a good. They developed a unit of measuring utility, which is known as utils.
For example, according to the cardinal utility concept, an individual gains 20 utils from ice-
cream and 10 utils from coffee. However, modern economists, such as J.R. Hicks, gave the
concept of ordinal utility of measuring utility. According to this concept, utility cannot be
measured numerically, it can only be ranked as 1, 2, 3, and so on. For instance, an individual
prefers ice-cream than coffee, which implies that utility of ice-cream is given rank 1 and coffee
as rank 2.

1. Cardinal Utility Concept: The numbers 1, 2, 3, 4 are cardinal numbers. For example
the number 2 is twice the size of 1. In the same way, the number 4 is four times the size of
number 1. Alfred Marshall developed cardinal utility analysis. According to cardinal approach,
utility can be measured. Cardinal utility is an important concept in utilitarianism and neo-
classical economics. Jeremy Bentham talked about utility as maximizing pleasure and
minimizing pain. The neo-classical economists propounded the theory of consumption
(consumer behavior theory) on the assumption that utility is cardinal. For measuring utility, a
term ‘util’ is coined which means units of utility.5

Assumptions of the cardinal utility concept that were followed by economists while
measuring utility6 –

a. One util equals one unit of money

b. Utility of money remains unchanged

5
http://www.economicshelp.org/blog/glossary/cardinal-utility/
6
http://www.yourarticlelibrary.com/consumers/measurement-of-utility-cardinal-utility-and-ordinal-utility/46782/
Over a passage of time, it is felt by many economists that utility cannot be measured exactly.
There are a lot of hindrances involved in the measurement of utility. The utility derived by a
consumer from a good depends on various factors, such as changes in consumer’s moods, tastes,
and preferences. These factors are not possible to determine and measure. Therefore, no such
technique has been devised by economists to measure utility. Utility; thus, is not measureable in
cardinal terms. However, the cardinal utility concept has a prime importance in consumer
behavior analysis.

2. Ordinal utility concept: The numbers 1st, 2nd, 3rd, and 4th, are ordinal numbers. These
ordinal numbers are ranked or ordered. This ranking does not explain the actual size relation of
the numbers. The second one might or might not be twice as big as the first one. Hicks and
Allen used ordinal utility approach for analyzing the consumer behavior. This analysis is known
as indifference curve analysis. In ordinal utility the consumer only ranks choices in terms of
preference but we do not give exact numerical figures for utility. For example, we prefer a BMW
car to a Nissan car, but we don’t say how much. It is argued this is more relevant in the real
world. When deciding where to go for lunch, we may just decide I prefer an Italian restaurant to
Chinese. We don’t calculate exact levels of utility.

Cardinal utility approach is based on the fact that the exact or absolute measurement of utility is
not possible. However, modern economists rejected the cardinal utility approach and introduced
the concept of ordinal utility for the analysis of consumer behavior. According to them, it may
not be possible to measure exact utility, but it can be expressed in terms of less or more useful
good.7

Neo- classical economists prefer cardinal utility in only practical situations whereas, modern
economists believe that utility is related to psychological aspect of consumers and cannot be
measured in quantitative terms. They also think that ordinal utility meets the theoretical needs of
consumer behavior analysis even when there is no cardinal measure of utility available.

7
http://www.yourarticlelibrary.com/consumers/measurement-of-utility-cardinal-utility-and-ordinal-utility/46782/
 Concepts of Utility

There are three concepts of utility:

1. Marginal Utility: Marginal utility is the utility derived from the last or marginal unit of
consumption. It refers to the additional utility derived from an extra unit of the given
commodity purchased, acquired or consumed by the consumer. According to Chapman,
“Marginal utility is the addition made to the total utility by consuming one more unit of
commodity”. For instance, assume that Mr. Choudhary is consuming Suntreat biscuits.
He consumes first biscuit by which he gets utility up to 20; second biscuit 16; third
biscuit 12; fourth biscuit 8 and final biscuit 2. If we will consume only four biscuits then
the marginal unit will be fourth bread and utility will be 8.

We can split marginal utility into three types:

a. Positive utility

b. Zero utility

c. Negative utility

It can better be understood by a table representation-

Number of biscuits Marginal Utility(MU) Kinds of MU

1 20

2 16

3 12

4 8

5 4 Positive Utility
 6 0 Zero Utility

7 -4 Negative Utility

From the table given above it is clear that up to the consumption of the fifth biscuit we receive
positive utility; 6th unit is the unit of full satisfaction i.e., Utility derive from that unit is zero.

From 7th unit the utility received will be negative utility.

Zero utility is when the consumption of a commodity makes no addition to the total utility, then

it is the point of zero utility. In our table the total utility after the 6th unit is consumed. This is
the point of Zero Utility. It is thus seen that the total utility is maximum when the Marginal
Utility is zero.

Negative Utility is after the utility is zero and still Mr. Choudhary consumes the 7th biscuit.
When one person consumes even after zero utility, it gives them dis-satisfaction instead of
satisfaction. The utility in such case is negative.

2. Total Utility: Total Utility is the utility from all units of consumption. According to
Mayers, “Total Utility is the sum of the marginal utilities associated with the
consumption of the successive units.” As we consume more units of a commodity, each
successive unit consumed gives lesser and lesser satisfaction that is marginal utility
diminishes. It is termed as the Law of Diminishing Marginal Utility.

Number of Biscuits Marginal Utility Total utility

1 20 20

2 16 36 = (20+16)

3 12 48 = (36+12)
 4 8 56 = (48+8)

5 4 60* = (56+4)

Total = 60*

3. Average Utility: Average Utility is that utility in which the total unit of consumption of
goods is divided by number of Total Units. The Quotient is known as Average Utility.
For example—If the Total Utility of 4 bread is 40, then the average utility of 3 bread will
be 12 if the Total Utility of 3 bread is 36 i.e., (36 ÷ 3 = 12).

Unit of Biscuit Marginal Utility Total utility (TU) Average utility

(MU) (AU)

1 16 16 16

2 12 (16+12) = 28 (28/2) = 14

3 8 (28+8) = 36 (36/3) = 12

4 4 (36+4) = 40 (40/4) = 10

5 0 (40+0) = 40 (40/5) = 8

6 -4 (40-4) = 36 (36/6) = 6

7 -8 (36-8) = 28 (28/7) = 4
 Law of Diminishing Marginal Utility

The more we have of a commodity, the less we want to have more of it. It is the experience of
every consumer that as he goes on consuming a particular commodity, each successive unit of
the commodity yields him less and less satisfaction. In other words, at each step its utility
(marginal utility) goes on decreasing. Thus if we are very thirsty and buy a drink to quench our
thirst, the drink will yield a great deal of satisfaction at first. After the consumption of the first
drink, however, we would not like to have another, because our want has been practically
satisfied. This is the case with most of the commodities.

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 definition 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.

There are certain assumptions to the law:

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:8 Table 1

No. of chocolates Marginal utility

First 4

Second 3

Third 2

Fourth 1

Fifth 0

Sixth -1

Figure 1

8
https://www.scribd.com/doc/19470190/Unit-III-Utility-Analysis-Economics
Table 1 explains:

 The table shows that first chocolate yields 4utils of marginal utility.
 The second chocolate will yield less marginal utility than the first one i.e. 3utils.
 Third will yield still less MU, say2utils.
 Fourth will yield just 1utils of MU. At this stage want may be fully satisfied.
 Thus fifth chocolate will yield zero MU. If you are forced to take sixth chocolate it may
upset system and yields negative utility say, -1 util.

Figure 1 explains:

 OX axis – Chocolate(Quantity)
 OY axis – Marginal Utility(MU)
 AB is Marginal Utility Curve (MUC)
 It slopes downward from left to right (negative slope) indicating first chocolates 4 utils,
second 3 utils, Third 2 utils and fourth 1util of marginal utility. Fifth chocolate yields
zero marginal utility.
 AB curve touches OX – axis at point C that represents fifth chocolate.
 Sixth chocolate yields negative marginal utility and so AB curve goes below OX – axis.

The limitations or exceptions of the law of diminishing marginal utility are as follows:9

1. The law does not hold well in the rare collections. For example, collection of ancient
coins, stamps etc.
2. The law is not fully applicable to money. The marginal utility of money declines with
richness but never falls to zero.
3. It does not apply to the knowledge, art and innovations.
4. The law is not applicable for precious goods.
5. Historical things are also included in exceptions to the law.
6. Law does not operate if consumer behaves in irrational manner. For example, drunkard is
said to enjoy each successive peg more than the previous one.

9
http://www.managedstudy.com/micro/law_of_diminishing_marginal_utility.htm
 7. Man is fond of beauty and decoration. He gets more satisfaction by getting the above
merits of the commodities.
8. If a dress comes in fashion, its utility goes up. On the other hand its utility goes down if it
goes out of fashion.
9. The utility increases due to demonstration. It is a natural element.

Importance of the Law of Diminishing Marginal Utility:

The importance or the role of the law of diminishing marginal utility is as follows:

1. By purchasing more of a commodity the marginal utility decreases. Due to this behavior,
the consumer cuts his expenditures to that commodity.
2. In the field of public finance, this law has a practical application, imposing a heavier
burden on the rich people.
3. This law is the base of some other economic laws such as law of demand, elasticity of
demand, consumer surplus and the law of substitution etc.
4. The value of commodity falls by increasing the supply of a commodity. It forms a basis
of the theory of value. In this way prices are determined.
 Law of Equi – Marginal Utility

The law of equi marginal utility was presented in 19th century by Australian economists H. H.
Gossen. It is also known as law of maximum satisfaction or law of substitution or Gossen's
second law. A consumer has number of wants. He tries to spend limited income on different
things in such a way that marginal utility of all things is equal. When he buys several things with
given money income he equalizes marginal utilities of all such things. The law of equi marginal
utility is an extension of the law of diminishing marginal utility. The consumer can get maximum
utility by allocating income among commodities in such a way that last dollar spent on each item
provides the same marginal utility.

Definition:

"A person can get maximum utility with his given income when it is spent on different
commodities in such a way that the marginal utility of money spent on each item is equal".

It is clear that consumer can get maximum utility from the expenditure of his limited income. He
should purchase such amount of each commodity that the last unit of money spend on each item
provides same marginal utility.

Assumptions of the Law of Equi Marginal Utility:

1. There is no change in the prices of the goods.

2. The income of consumer is fixed.
3. The marginal utility of money is constant.
4. Consumer has perfect knowledge of utility obtained from goods.
5. Consumer is normal person so he tries to seek maximum satisfaction.
6. The utility is measurable in cardinal terms.
7. Consumer has many wants.
8. The goods have substitutes.
Explanation With Schedule and Diagram:

The law of substitution can be explained with the help of an example. Suppose consumer has six
dollars that he wants to spend on apples and bananas in order to obtain maximum total utility.
The following table shows marginal utility (MU) of spending additional dollars of income on
apples and bananas:

Table2.

Money (units) MU of apples MU of bananas

1 10 8
2 9 7
3 8 6
4 7 5
5 6 4
6 5 3

Table 2 shows that:

1. Rs. 1 on apples and Rs. 5 on bananas. The total utility he can get is : [(10) +
(8+7+6+5+4)] = 40
2. Rs.2 on apple and Rs. 5 on banana. The total utility he can get is: [(10+9) +
(8+7+6+5)] = 45.
3. Rs.3 on apples and Rs. 3 on bananas. Total utility he can get is: [(10+9+8) + (8+7+6)]
= 48.
4. Rs.4 on apples and Rs.2 on bananas. The total utility he can get is: [(10+9+8+7) +
(8+7)] = 49.
5. Rs. 5 on apples and Rs. 1 on bananas. The total utility he can get is: [(10+9+8+7+6)
+ (8)] = 48.

Total total utility for consumer is 49 utils that is the highest obtainable with expenditure of Rs.4
on apples and Rs.2 on bananas. Here the condition MU of apple = MU of banana i.e 7 = 7 is also
satisfied. Any other allocation of the last dollar shall give less total utility to the consumer.
The diagram shows that consumer has income of Rs.6. He wants to spend this money on apples
and bananas in such a way that there is maximum satisfaction to the consumer.

Limitations:

1. The law is not applicable in case of knowledge. Reading of books provides more
satisfaction and knowledge to the scholar. Different books provide variety of knowledge
and satisfaction.
2. The law is not applicable in case of indivisible goods. The consumer is unable to divide
the goods to adjust units of utility derived from consumption of goods.
3. There is no measurement of utility. It is psychological concept. It is not possible to
express it into quantitative form.
4. The law does not hold well in case fashion and customs. The people like to spend money
on birthdays, marriages and deaths.
5. The does not hold well in case of very low income. The maximization of utility is not
possible due to low income.
6. The law is not applicable in case of durable goods. The calculation of marginal utility of
durable goods is impossible.
7. The law fails when goods of choice are not available. The consumer is bound to use
commodity, which provides low utility due to non availability of goods having high
utility.
 8. There are certain lazy consumers. They do not care for maximum utility. The law fails to
operate in case of laziness of consumers. They go on consuming goods with comparing
utility.
9. It does not work when there are frequent prices changes. The consumer is unable to
calculate utility of different commodities. Changing price levels create confusion in the
minds of consumers.
10. There may be unlimited resources. The does not work due to unlimited resources. There
is no need to change the direction of expenditure from one item to another when there are
gifts of nature.

Importance:

1. The law of equi marginal utility is helpful in the field of production. The producer has
limited resources. He uses limited resources to purchase production factors. He tries to
equalize marginal utility of all factors. He wishes to get maximum output and profit.
2. National income is distributed among factors of production according to this law. An
entrepreneur can pay factors of production equal to marginal product measured in money
terms. He will substitute one factor for another until marginal productivity of all factors is
equal to prices of their services.
3. The law is used in the field of exchange. The people like to exchange a commodity
having low utility with a commodity having high utility. There is maximum benefit from
exchange of commodities. The law is helpful in exchange of wealth, trade, import and
export.
4. The law is applicable in consumption. A rational consumer tries to get maximum
satisfaction when he spends his limited resources on various things. He tries to equalize
weighted marginal utility of all the things.
5. The law is applicable in public finance. The government can spend its revenue to get
maximum social advantage. The marginal utility of each dollar spent in one sector must
be equal to marginal utility derived from all other sectors.
6. The law is useful for workers in allocating the time between work and rest. They can
compare the marginal utility of work and the marginal utility of rest. They can decide
working hours and rest hours.
7. The law holds well in case of saving and spending. The consumer can make choice
between present wants and future wants. He can feel that a dollar saved has greater utility
than a dollar spent, he can save more and spend less. He will substitute saving and
spending till marginal utility of a dollar spent and a dollar saved are equal.
8. The law is helpful in prices. Due to scarcity of commodity its prices go up. The law tells
us to use substitute commodity, which is less scarce. The result is that the price of
commodity comes down.
 Analysis

The consumer plays a very important role in the economic activity. He satisfies his wants by
consuming goods and services. All economics activities play sole purpose of satisfaction of
wants. The concept of utility very well explains how a consumer satisfies his want by consuming
any goods and services. Utility is however different from satisfaction. Utility implies potentiality
of satisfaction in a commodity; it serves a basis to induce the consumer to buy the commodity.
But the real satisfaction is the end result of the consumption of a given commodity. For the sake
of better understanding and to avoid confusion economists use both these terms interchangeably.
Utility being an introspective phenomenon cannot be measured directly in a precise manner.
There cannot be a direct numerical expression of utility. But some economists have adopted an
indirect measurement of utility in term of price a consumer is willing to pay for a given
commodity, higher the price higher the utility. There are two basic approaches to the
measurement of utility (i) Cardinal and (ii) Ordinal utility.

Cardinal measurement of utility was supported by a group of economists. They believed that
utility of a commodity is quantifiable. In simple word, utility can be measured numerically.
Hence, they came up with a term that helped them to measure utility i.e. ‘Utils’.

Whereas, other group of economists believed that utility cannot be quantified and numerical
representation is unrealistic. They were of the view that utility was only measurable in the
ordinal way which means 1st 2nd 3rd etc. order of satisfaction.

The concept of cardinal utility is mostly preferred. In the cardinal measurement of utility, total
utility and marginal utility are the basic concepts.

Total utility means the total satisfaction attained by the consumer regarding all the units of a
commodity taken together in consumption or acquired at a time. Marginal utility on the other
hand, refers to the additional utility obtained from an additional unit of any commodity that is
consumed. There are two fundamental laws relating to marginal utility that are as follows:

1. Law of Diminishing marginal utility- This law expresses the mode of consumer’s
satisfaction of a commodity. This law explains basic consumer behavior in terms of
 demand. It says that with consumption of every additional unit of the commodity,
satisfaction of the consumer decreases. In simple words as the consumption increases, the
utility derived from it decreases.

2. Law of Equi-marginal utility- It is an extension of the law of diminishing marginal utility.

It is also called the law of maximum satisfaction. It says that a consumer may want more
than one particular commodity. It states that other things being equal, a consumer gets
maximum total utility from spending his given income, when he allocates his expenditure
to the purchase of different goods in such a way that the marginal utilities derived from
the last units of money spent on each item of expenditure tend to be equal.

The concept of utility is in the terms of consumer satisfactions and also it focuses on how a
consumer can satisfy his want in more efficient way within a given amount. In short, although
utility analysis is based on many unrealistic and impractical assumptions, yet being the first
theory seeking to determine consumer’s equilibrium, it will continue to occupy an important
place. It is worth mentioning that indifference analysis and revealed preference analysis have
their genesis in the scathing criticism of cardinal utility analysis.