Utility & Demand

CHAP-8
Utility
Benefits or satisfaction from consumption of goods and services.

Total Utility: Total benefit from different types of goods and

services.
Marginal Utility: Change in total utility due to one unit increase in
quantity of goods consumed.
Diminishing Marginal Utility
oThe tendency for marginal utility to decrease as the quantity
consumed of a good increases.
 Example

As an example assume you have one ice

cream,

1 Ice Cream you feel Ecstatic

You have a second Ice cream

2nd Ice Cream, u still feel Ecstatic

5
 You have the third Ice cream

3rd Ice Cream You Feel Very Happy

6
 You have the fourth Ice Cream

4th Ice Cream You Feel Happy

7
 You have the fifth Ice Cream,

5th Ice Cream You Still Feel

Happy

8
 You have the sixth Ice Cream

6th Ice Cream You are not

so Happy
9
 You have the seventh Ice Cream

7th Ice Cream You are not

so Happy
10
 You have the eighth Ice Cream

8th Ice Cream

You fall sick
11
The following table will make the law of diminishing
marginal utility more clear
Total & Marginal Utility
Cardinal & Ordinal Utility
Cardinal utility states that the satisfaction that the consumer derives
by consuming goods and services can be measured with numbers.
Ordinal utility states that the satisfaction that the consumer derives
from the consumption of goods and services cannot be measured in
numbers. Rather, ordinal utility uses a ranking system in which a
ranking is provided to the satisfaction that is derived from
consumption.
• While cardinal utility is a quantitative measure, ordinal utility is a
qualitative measure.
Budget Line
•Marks the boundary between combination of goods and services
that household can afford. Income $40, movie $8, Soda $4 a case
Marginal Utility Per Dollar
Marginal utility per dollar is the marginal utility from a good that
results from spending one more dollar on it.

Marginal utility per dollar from movies= MUm/Pm

Marginal utility per dollar from soda= MUs/Ps

Utility-Maximization Rule
Spend all the available income
Equalize the marginal utility per dollar for all goods
Equalizing Marginal utilities per dollar
Per dollar utility from movie=50/8=6.25
Per dollar utility from soda=10/4=2.50
Equimarginal Principle
Equimarginal Principle states that a consumer having fixed income
and facing given market prices of goods will achieve maximum utility
when marginal utility per dollar spent on each good is exactly the
same as the marginal utility per dollar spent on any other good.
The paradox of Value

Water is needed for life but diamond is require for decoration.

Why water is cheaper than diamond---------Paradox of value.

The paradox of Value
The marginal utility per dollar is the same for diamonds and water.

Water is cheap but brings large consumer surplus

Diamonds are expensive but brings a small consumer suplus.
The paradox of Value