Value, Utility, Economic

Aspects of Exchange
VALUE
• Measure of worth that a person ascribes to a good or a service

• It is not inherent in the object

• It is human being’s perception

• Don’t get confused between Value & Cost/Price

UTILITY
• It is a measure of power of a good or a service to satisfy human wants
• It is the satisfaction that he/she derives from the product/service
• Utility in the minds of the consumer is related to desire
• Abhorrence, Indifference, Intense Desire
• Utility changes with time
• If the supernatural is excluded, all that has utility is physically manifested
• It is true with respect to intangible things as well. Eg: Music, Pictures,
Friendship
Theory of Utility
• Ranking Options - An individual can rank any number of options based on
their utility and the amount of satisfaction they'll gain from each

• More Total Utility is Better - For a good, service, or any other item, having
more total utility is always better than having less as it points to more
gratification found in the good, service, or item

• Variety is Better - To have a diversified set of goods is better than to have

a set of only one good. This is due to the increased usefulness found in
differing goods compared to a single good

• Rational Consumers - It is generally assumed that individuals are rational

decision makers who'll always make the best choice in light of utility
Theory of Marginal Utility
• Marginal utility is the added satisfaction that a consumer gets from
having one more unit of a good or service
• Positive marginal utility occurs when the consumption of an additional
item increases the total utility
• Negative marginal utility occurs when the consumption of one more unit
decreases the overall utility
• The concept of marginal utility is used by economists to determine how
much of an item consumers are willing to purchase
• Marginal utility can be positive, zero, or negative
Increasing Marginal Utility
• When building a stool, the first two legs appear to have little value
because the stool cannot stand. However, there is great value placed
on the third leg, because it is needed for the stool to stand up.

• There is greater satisfaction in finding the 52nd card of a deck of cards

than in finding the first 51, because it completes the deck.

• There is greater satisfaction in finding the second shoe than there was
in finding the first, since the second shoe gives you a complete pair of
shoes.
Diminishing Marginal Utility
• Consuming one candy bar may satisfy a person's sweet tooth. If a
second candy bar is consumed, the satisfaction of eating that second
bar will be less than the satisfaction gained from eating the first. If a
third is eaten, the satisfaction will be even less.

• After holding your breath under water, coming up for air and taking
that first breath feels wonderful. The second breath may bring
satisfaction as well, but the satisfaction will decrease as more breaths
are taken.
 Utility Analysis: Consumer Behaviour
Goods and services as the capacity to satisfying human wants with the help of
consumption activities

All engineering activity is to supply goods and services that people may consume
to satisfy their needs and desires
Every individual tries to maximise his satisfaction by consuming product with the
limited income at a particular time

Total Utility Marginal Utility

1 unit TU1 = U1 2nd unit MU2 = TU2 – TU1
2 units TU2 = U1 + U2 3rd unitMU3 – TU2
3 units TU3 = U1 + U2 + U3 nth units TUn – TUn-1
n units TUn = U1 + U2 + U3 + …Un
 Meaning of Utility
 Production angle: utility is the want-
satisfying power of a commodity
 Consumer’s angle: utility is the
psychological feeling of satisfaction,
pleasure, happiness of well-being,
which a consumer derives from the
consumption possession or the use of a
commodity.
 The term utility in Economics is used
to denote that goods and services as
the capacity to satisfying human
wants with the help of consumption
activities.
 In, other words utility is defined as the
want satisfying power of a commodity.
 Utility is the benefit or satisfaction
that a person gets from the
consumption of a good or service.
 According to, Mrs. Robinson, “Utility
is the quality in commodities that
makes individuals want to buy them.”
 According to Hibdon, “Utility is the
quality of a good to satisfy a want.”
 Total Utility
 Utility is measurable and additive
 Total utility is the sum total of utilities
obtained by the consumer from the
various units of a good or service he
consumes at a point or over a period
of time.
 Suppose a consumer consumes four
units of a commodity, X, at a time
and derives utility from the successive
units of consumption as U1, U2, U3
and U4
 His total utility (Ux) from commodity
X can be then measured as follows
Ux = U1 + U2 + U3 + U4
Total utility generally increases as the
quantity consumed of a good increases.
TU = U1 + U2 + U3 + U4
 If he consumes n units, the total utility
(TU) from n units can be expressed as
TUn = U1 + U2 + U3 + ………. Un
 In case the number of commodities
consumed and their units are greater
than one, then
TU = TUx + TUy + TUz + …….. + TUn
 Where subscripts x, y, z and n denote
commodities
 Marginal utility (MU)
 Marginal utility can be defined as the
utility derived from the marginal or
one additional unit consumed.
 It may also be defined as the utility
derived from the marginal or one
additional unit consumed.
 Algebraically, the marginal utility
(MU) of on units of a commodity is
the total utility (TU) of n units minus
the total utility of n-1.
MU = TUn – Tun - 1
 Marginal Utility(MU) thus refers to the
change in the total utility obtained from
the consumption of an additional unit
of a commodity, say X
 Assumptions of Utility Analysis
1. Utility is cardinal
2. Utility being quantifiable is additive (measurable in terms of money)
3. Various units of a commodity consumed are homogenous (consumption
of 200 ml bottles of a soft drink)
4. There is no time gap between the consumption of successive units. The
consumer goes on consuming the units one by one, without any break.
5. The consumer is rational, i.e., he has perfect knowledge and maximises
utility.
6. The tastes and preferences of the consumer remain unchanged.
7. The marginal utility of money is constant. Here the marginal utility of
money is the change in total utility that results from spending one
additional unit of money.
 The Law of Diminishing Marginal Utility
 The law of diminishing marginal utility is one of the fundamental
laws of economics pertaining to the analysis of consumer
behaviour.
 The law states that as the quantity consumed of a commodity
goes on increasing, the utility derived from each successive unit
consumed goes on decreasing, consumption of all other
commodities remaining constant.
 In simple words, when a person continues to consume more and
more units of a commodity at a point of time e.g., chocolates, the
utility that he drives from each successive chocolate goes on
diminishing.
 The utility of commodity depends on the intensity or urgency of
the need for that commodity.
 If the more and more quantity of a commodity is consumed, the intensity
of desire decreases and therefore the utility derived from the marginal unit
decreases.
 For example, suppose you are very hungry and you are offered sandwiches
to eat.
 The satisfaction which you derived from the first piece of sandwich would
be the maximum because intensity of your hunger was the highest.
 When you eat the second piece, you derive a lower satisfaction because
intensity of your hunger is reduced due to consumption of one piece of
sandwich.
 As you go on eating more and more sandwiches, the intensity of your
hunger goes on decreasing and therefore the satisfaction which you derive
from the successive units goes on decreasing.
 This phenomenon is generalised in the form of a theory called the Law of
Diminishing Marginal Utility
 Total and Marginal Utility

Total Utility Marginal Utility

0 0 -

1 30 30

2 50 20

3 60 10

4 65 5

5 60 -5

6 45 -15
 Numerical Example
 The table present a numerical
illustration of the law of
diminishing marginal utility.
 As the table shows, total utility
(TU) increases with increase in
consumption of sandwiches, but at a
decreasing rate.
 It means that MU decreases with
increase in consumption – this is
shown in the last column of the
table.
Limitation of Law of Diminishing Marginal Utility

1. Homogeneous units
2. No change in Tastes
3. Continuity
4. Suitable size units
5. Constant Prices
6. Indivisible Goods
7. Rational Consumers
8. Ordinary goods
9. MU of Money not constant
1. Homogeneous Units
 There should be a single commodity with homogeneous units wanted
by an individual consumer.
 All units of the commodity should be of the same weight and quality.
 If for example, the first apple is sour and the second sweet, the second
will give greater satisfaction than the first.
2. No change in Tastes and habits
 There should be no change in the tastes, habits, customs, fashions and
income of the consumer.
 A change in any one of them will increase rather than diminish utility.
 3. Continuity
 There should be continuity in the consumption of the commodity.
 Units of the commodity should be consumed in succession at one
particular time. Pieces of bread taken at random may increase utility.
4. Suitable size units
 Units of the commodity should be of a suitable size. Giving water to a
thirsty person by spoons will increase the utility of the subsequent
spoons of water.
 5. Constant prices
 Prices of the different units and of the substitutes of the commodity should
remain the same.
6. Individual goods (Durable goods)
 The commodity should not be indivisible. In the case of durable consumer
goods it is not possible to calculate their utility because their use is spread
over a period of time.
 Moreover, a consumer does not buy five scooters, six television sets or
even three sewing machines for his personal consumption.
7. Rational Consumers
 The consumer should be an economic man, who acts rationally.
 If he is under the influence of an intoxicant, say wine or opium, the
utility of the later units will rise.
 But this exception is not wholly true. In the beginning the marginal
utility of each peg rises but ultimately it starts falling and even
becomes negative when a drunkard starts vomiting.
 8. Ordinary Goods
 Goods should be of an ordinary type. If they are commodities, like diamonds and
jewels or hobby goods like stamps, coins or paintings, the law does not apply.
 The utility of the additional coins or jewels may be greater than the earlier pieces.
 But this view is not correct. For the law also applies in their case.
 The collector of coins or jewels will never like to have innumerable pieces of the
same coin or jewels.
 Similarly, the marginal utility of the second set of a particular issue of stamps will
diminish for the stamp collector if he already possesses one.
Economic Aspects of Exchange
• Exchange of utilities by two or more people

Mutual Benefit in Exchange:

• An exchange will not benefit unless both buyer and seller don’t believe they will
benefit
• Objects of exchange need not be valued equally by both parties
• Each party in exchange should seek to give something that has lesser utility to him
and will have greater utility for the receiver
• Utility need not be exchanged only with money

• Range of Mutual benefit in Exchange :

It is the difference between utility of a good for a buyer and the utility it has for a seller
This difference is available to for division between buyer and seller
Persuasion in Exchange:
• It is common for offers to get rejected. But why?
• Sales people try to induce utility
• Salesman succeeds to sell the product. How?
- Salesman succeeded to make you believe that there is utility in the product
- Salesman’s function is to call attention
• Persuasive ability is richly rewarded
• Advertisements and sales promotion
• Factual approach of salesman
• Emotional approach of salesman
• Engineering economics is directed towards analysis of economy on a
factual basis as much as possible.