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Consumption

• Utility Analysis of Demand • Law of Diminishing Marginal Utility

FHRAI Institute of Hospitality Management, Micro Economics

Page 1 of 11 Amit Bhatnagar

Utility Analysis of Demand
• The demand for a commodity by a consumer is based on the expectation that the commodity will fetch him the desired satisfaction.

This demand of the consumer depends on factors like; price of the commodity, income of the consumer, and more important on his taste & preferences. The satisfaction which the consumer derives is measured in terms of utility of that commodity.
The utility analysis of demand is broadly divided into two methods: – Cardinal Utility Approach – given by Marshall – Indifference Curve Analysis – given by Hicks


FHRAI Institute of Hospitality Management, Micro Economics

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Concepts related to the two approaches:
• • Utility: The want satisfying power of the commodity is known as utility. Total Utility: The total satisfaction derived by the consumer when he consumes a certain amount of the commodity is termed as total utility. Average Utility: It is, total utility divided by the number of units. It is also termed as, per unit amount of utility. Marginal Utility: It is additional utility derived out of an additional unit consumed. According to Prof. Boulding, “marginal utility of any quantity of commodity is the increase in the total utility which results from a units increase in consumption”. Thus it may be summarized as: Mu(n) = Tu(n) – Tu(n-1)

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e.g: Units of commodity X Total Utility Marginal Utility

1
2 3
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10
20 30

10 10
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Cardinal Utility Approach
• As Marshall stated, that utility of a commodity is quantifiable, therefore according to the cardinal analysis, the utility is measured in terms of units. Thus when satisfaction is measured in mathematical terms, it is referred to as Cardinal Utility. The Cardinal Approach is best explained with the help of Law of Diminishing Marginal Utility.

FHRAI Institute of Hospitality Management, Micro Economics

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The Law of Diminishing Marginal Utility
• The Law states: “Other things being equal, as the quantity of commodity consumed or acquired by the consumer increases, the marginal utility of the commodity tends to diminish” The principle behind the law is that, as an individual consumer consumes more and more of a commodity, his desire for the commodity gradually decreases and he consumes less of that commodity, as he is indifferent to it. This tendency of the consumer is reflected in every commodity consumer consumes. Marshall has defined the law, as “The additional benefit which a person derives from a given of his stock of a thing, diminishes with every increase in the stock that he already has”.
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Utility Schedule
Units of Total Utility commodity 1 20 2 37 3 49 4 58 5 64 6 64 7 62
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Marginal Utility 20 17 12 9 6 0 -2
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Law of Diminishing Marginal Utility Curve
70 60 50 40 30 20 10 0 -10 1 2 3 4 5 6 7 Series1 Series2

Series 1 – Total Utility Series 2 – Marginal Utility
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Assumptions of the Law
• The successive units of the commodities consumed should be identical & homogeneous in all respects without any difference, or the consumer would obtain more satisfaction by consuming the additional commodity than get less satisfied. The consumption process should be continuous, in order to measure its utility. The unit consumed should be of standard unit. The consumer is expected to be rational in his approach to measure his utility. The taste of the consumer is assumed to be constant. It is also assumed that utility of the consumer is numerically measured.

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FHRAI Institute of Hospitality Management, Micro Economics

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Importance of the Law
• Has laid the foundation for Law of Demand • Helps in scaling the preferences of the consumer. • Explains the paradox of Valuein-use & Value-in-exchange.

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Queries ?

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Thank You

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