MODULE 5: The Concepts of Utility

Learning Outcomes:

At the end of the course, the student is able to:

Define utility;
Identify the different factors that affect utility and consumption behavior;and
Discuss the law of diminishing marginal utility.

Teaching-Learning Activity:

Individual activities and activities that will ask you to share and discuss with your
co-learners are also provided. The application of concepts will be through case study.

Utility
Economic utility refers to the usefulness or value that consumers experience from
a product or service and can be judged based on the form, time, place and possession,
these factors help in assessing the purchase decisions and the drivers behind those
decisions.
Utility is defined as the satisfaction derived from consumption of a commodity
which determines consumption and demand behavior. It is the foundation of
consumer’s behavior. Consumers buy for reasons, one of the reason is the usefulness of
the good or service. This is the usefulness or value that consumers experience from a
product. The economic utilities help assess consumer purchase decisions and pinpoint
the drivers behind those decisions.
Companies strive to increase the utility or perceived value of their products and
services to enhance customer satisfaction, increase sales, and drive earnings. The
concept of economic utility falls under the area of study known as behavioral
economics. It is designed to assist companies in operating a business and marketing the
company in a way that is likely to attract the maximum amount of customers and sales
revenues.

Four Types of Utility

Form utility refers to how well a product or service meets the customer’s needs. When
utility increases due to the change in the shape or structure of existing material. For
example, a company might design a product to target a specific client’s needs and
wants. Form utility is the incorporation of customer needs and wants into the features
and benefits of the products being offered by the company. Form utility include
offering consumers lower prices, more convenience, or a wider selection of products.
The goal of these efforts is to increase and maximize the perceived value of the
products.

Time utility exists when a company maximizes the availability of a product so that
customers can buy it during the times that are the most convenient or desirable for
them. Companies analyze how to create or maximize their product’s time utility and
adjust their production process, logistical planning of manufacturing, and delivery.
Creating time utility includes considering the hours and days of the week a company
might choose to make it services available. For example, a store might open on the
weekends if customers typically shop for that product at that time.

Place utility refers primarily to making goods and services physically available or
accessible to potential customers. Having a product where customers can buy it. It
includes location and transporting the product to the location. Examples of place utility
range from a retail store’s location to how easy a company’s website or services are to
find on the internet. Increasing convenience for customers can be a key element in
attracting business. A company that offers easy access to technical assistance offers an
added value in comparison to a similar company that does not offer a similar service.
Making a product available in a wide variety of stores and locations is considered an
added value since its more convenient. For example, Apple Inc. Sells iPhones and
laptops through its retail stores, but also offers its products through other electronics
retailers, including Best Buy Co. Inc.

Possession utility is the amount of usefulness or perceived value from owning a product.
The exchange of a product for some monetary value. For example, owning a car or
truck might be considered to have a high possession utility. For example, offering
favorable financing terms toward ownership of a car, appliance, or home would likely
create possession utility for those products and lead to increased sales.

Factors that affect Utility

Cultural Factors
Cultural factors exert the broadest and deepest influence on consumer behavior.
Culture is one of the most fundamental determinants of a person’s wants and behaviors.
Values of individuals or peoples are highly influenced by cultural environment.
A group of people are associated with a set of values and ideologies that belong to a
particular community. When a person comes from a particular community, his/her
behavior is highly influenced by the culture relating to that particular community. Some
of the cultural factors are:
Culture
Cultural Factors have strong influence on consumer buyer behavior. Cultural Factors
include the basic values, needs, wants, preferences, perceptions, and behaviors that
are observed and learned by a consumer from their near family members and other
important people around them.
Subculture
Within a cultural group, there exists many subcultures. These subcultural groups share
the same set of beliefs and values. Subcultures can consist of people from different
religion, caste, geographies and nationalities. These subcultures by itself form a
customer segment.
Social Class
Each and every society across the globe has form of social class. The social class is not
just determined by the income, but also other factors such as the occupation, family
background, education and residence location. Social class is important to predict the
consumer behavior.

Social Factors
A consumer’s behavior is influenced by social factors such as the consumer’s
reference groups, family, and social roles and statuses.
Reference groups are those groups that have a direct or indirect influence on
person’s attitudes or behaviors.Members of the buyer’s family can exercise a strong
influence on the buyer’s behavior. A person’s position in each group can be defined in
terms of role and status. A role consists of the activities a person is expected to perform
according to the person around him or her.

Personal Factors
Factors that are personal to the consumers influence their buying behavior.
These personal factors differ from person to person, thereby producing different
perceptions and consumer behavior.
Some of the personal factors are:
Age
Age is a major factor that influences buying behavior. The buying choices of youth
differ from that of middle-aged people. Elderly people have a totally different buying
behavior. Teenagers will be more interested in buying colorful clothes and beauty
products. Middle-aged are focused on house, property and vehicle for the family.
Income
Income has the ability to influence the buying behavior of a person. Higher income
gives higher purchasing power to consumers. When a consumer has higher disposable
income, it gives more opportunity for the consumer to spend on luxurious products.
Whereas low-income or middle-income group consumers spend most of their income
on basic needs such as groceries and clothes.
Occupation
Occupation of a consumer influences the buying behavior. A person tends to buy
things that are appropriate to this/her profession. For example, a doctor would buy
clothes according to this profession while a professor will have different buying pattern.
Lifestyle
Lifestyle is an attitude, and a way in which an individual stay in the society. The buying
behavior is highly influenced by the lifestyle of a consumer. For example when a
consumer leads a healthy lifestyle, then the products he buys will relate to healthy
alternatives to junk food.
Economic Factors
The consumer buying habits and decisions greatly depend on the economic
situation of a country or a market. When a nation is prosperous, the economy is strong,
which leads to the greater money supply in the market and higher purchasing power
for consumers. When consumers experience a positive economic environment, they
are more confident to spend on buying products.
Whereas, a weak economy reflects a struggling market that is impacted by
unemployment and lower purchasing power.
Economic factors bear a significant influence on the buying decision of a consumer.
Some of the important economic factors are:
Personal Income
When a person has a higher disposable income, the purchasing power increases
simultaneously. Disposable income refers to the money that is left after spending
towards the basic needs of a person.
When there is an increase in disposable income, it leads to higher expenditure on
various items. But when the disposable income reduces, parallelly the spending on
multiple items also reduced.
Family Income
Family income is the total income from all the members of a family. When more people
are earning in the family, there is more income available for shopping basic needs and
luxuries. Higher family income influences the people in the family to buy more. When
there is a surplus income available for the family, the tendency is to buy more luxury
items which otherwise a person might not have been able to buy.
Consumer Credit
When a consumer is offered easy credit to purchase goods, it promotes higher
spending. Sellers are making it easy for the consumers to avail credit in the form of
credit cards, easy installments, bank loans, hire purchase, and many such other credit
options. When there is higher credit available to consumers, the purchase of comfort
and luxury items increases.
Liquid Assets
Consumers who have liquid assets tend to spend more on comfort and luxuries. Liquid
assets are those assets, which can be converted into cash very easily. Cash in hand,
bank savings and securities are some examples of liquid assets. When a consumer has
higher liquid assets, it gives him more confidence to buy luxury goods.
Savings
A consumer is highly influenced by the amount of savings he/she wishes to set aside
from his income. If a consumer decided to save more, then his expenditure on buying
reduces. Whereas if a consumer is interested in saving more, then most of his income
will go towards buying products.
The Utility Function
Utility is the technical term for satisfaction. There is a functional relationship
between utility and consumption as the need for the latter arises.
Total utility (TU) - the total amount of satisfaction derived from consuming foods
and services.
Marginal utility (MU)- the additional satisfaction derived from consumption of
additional goods and services.

This functional relationship assumes two forms and is quantitatively defined as

follows:
TU= Function of Q (consumption)

MU= Change in TU (Satisfaction from an additional unit of consumption)

Change in Qty

Utility Schedule
Consumption Total Utility Marginal Utility
1 7 7
2 13 6
3 18 5
4 22 4
5 25 3
6 27 2
7 28 1
8 28 0
9 27 1
10 25 -2
11 22 -3
12 18 -4
13 13 -5
14 7 -6
15 0 -7

The Law of Diminishing Marginal Utility

The Law Of Diminishing Marginal Utility states that all else equal as consumption
increases the marginal utility derived from each additional unit declines. Marginal
utility is derived as the change in utility as an additional unit is consumed.
The Law of Diminishing Marginal Utility Explained
Whenever an individual interacts with an economic good, that individual acts in a way
that demonstrates the order in which they value the use of that good. Thus, the first unit
that is consumed is dedicated to the individual's most valued end. The second unit is
devoted to the second most valued end, and so on. In other words, the law of
diminishing marginal utility postulates that when consumers go to market to purchase a
commodity, they do not attach equal importance to all the commodities they buy.
They will pay more for some commodities and less for others.
References:

Managerial Economics by Villegas

Introductory to Macroeconomics by Pagoso et al

Introductory to Microeconomics by Pagoso et al

Economics by Fajardo

https://www.investopedia.com