WHAT IS UTILITY?

Utility may be defined as the power of goods and

services to satisfy wants. It refers to “the pleasure or
satisfaction associated with having, using, consuming,
or benefiting from goods or services.”
The quality of the product or service is primarily
responsible for its power to satisfy wants. Examples of
the causes and sources of utility are security, pride,
power, pleasure, comfort, ease of use, etc.
MEASURING UTILITY
The pleasure or satisfaction derived from using a
product or service is psychological and thus, is
incapable of measurement in absolute terms. The
problem of measurement must be hurdled however, if
one wants to proceed with understanding the
principles of economic behavior. In this regard,
economists have proposed two ways of measuring
utility:
1. The cardinal utility approach, and
2. The ordinal utility approach.
The cardinal utility approach refers to the
measurement of utility by assigning numerical values,
referred to as utils, such as 1 util, 12 utils, 140 utils or
-35 utils.
The ordinal utility approach measures utility in terms
of rank, such as those indicating levels from most
satisfying to least satisfying, best to worst, and highest
to lowest.
THE CONCEPT OF MARGINAL UTILITY
The satisfaction of human wants is the purpose of
using products and services. Individual persons
obtain satisfaction at increasing levels as they
consume the product or service in succession. This
means that the total utility of the product or service
increases as more units are consumed. This increase
in utility is called marginal utility. In more precise
terms, marginal utility refers to “the satisfaction an
individual receives form consuming one additional
unit of good or service.”
SCHEDULE OF TOTAL AND MARGINAL
UTILITY FOR MARIA SUNGA
Guavas Consumed Total Utility Marginal Utility
(in pieces) (in utils) (in utils)
1 50 50
2 80 30 (or 80-50)
3 100 20 (or 100-80)
4 110 10 (or 110-100)
5 90 -20 (or 90-110)
6 20 -70 (or 20-90)

The law of diminishing marginal utility states that “the amount of

extra or marginal utility declines as a person consumes more and
more of a good.”
 UTILITY MAXIMIZATION
It is expected that the rational consumer will attempt
to choose an option that will offer him maximized
utility. Let us assume that Maria Sunga is determining
what combination of two goods (ice cream and
chocolate bar) must she purchase to obtain maximum
satisfaction with her limited fund of one hundred
pesos. Maria is confronted with the price of ice cream
at P20 per cone and P15 for a bar of chocolate,
regardless of how many are bought. From Maria’s point
of view, the utility of the items in various quantities are
shown in the next table.
 Quantity From ice cream From Chocolate bars
consumed Total Marginal Total Marginal

0 0 0 0 0
1 14 14 9 9
2 22 8 17 8
3 24 2 24 7
4 24 0 27 3
5 21 -3 29 2
6 10 -11 30 1
The utility of the first cone of ice cream is 14 utils
from Maria’s point of view. Total utility (TU) goes up
as more cones of ice cream are consumed until it
reaches the highest TU point at 3 cones. The TU at
the fifth and sixth cones decline as Maria’s need is
fully satisfied. The marginal utility (MU) for ice cream
is highest with the first cone and declines with the
second and third cones. The MUs decline further with
the fifth and sixth cones registering negative figures.
The highest TU for chocolate is with 6 bars but the
lowest MU is also derived from 6 bars. With the
budget constraint of P100, only 6 combinations of ice
creams and chocolate bars are possible. Shown in the
next table are the various combinations. The
maximum utility that Maria can derive from spending
her P100 is with combination 2, i.e. two conefuls of ice
cream and four bars of chocolate.
Combination Quantity Total Price Total utils
Ice cream Choco bars
1 1 5 95 43
2 2 4 100 49
3 3 2 90 41
4 4 1 95 33
5 5 0 100 21
6 0 6 90 30
INDIFFERENCE ANALYSIS
Another technique used in the analysis of consumer
demand is based on the notion of ordinal utility. This
means that when the consumer is faced with a set of
alternative “bundles” of goods, he is able to rank them
all in order of preference. When confronted by any
two bundles, for instance, he is able to say whether he
prefers one to the other, or whether he is indifferent
between them (which means he regards them as
equally desirable or equivalent).
INDIFFERENCE SCHEDULE
Combination Mangoes Guavas
(in pieces) (in pieces)
1 12 2
2 10 4
3 8 6
4 6 8
5 4 10
6 2 12
THE INDIFFERENCE CURVE
When the indifference schedule is plotted on a graph,
the line joining all points is referred to as the
indifference curve. All points in the curve indicate
their respective combinations of goods and services
which yield equal levels of satisfaction.
SUBSTITUTION
Most often, consumers use substitute goods to satisfy
their wants. Commodities which can be used or consumed
in place of other goods are referred to as substitute goods.
The substitution option is exercised by the consumer
when there are available goods and services which yields
the same level of satisfaction but at lower costs.
If a rise in the price of a good causes an increase in the
demand for another, these two goods qualify as
substitutes. When two or more substitutes are available,
the consumers will generally choose the lowest-priced
commodity.
TYPES OF SUBSTITUTES
Substitutes may be classified as:
1. Close substitutes, and
2. Weak substitutes.
A close substitute provides an almost or equal level of
satisfaction as that of the substituted good or service.
For example, pineapple may be considered a close
substitute for mangoes.
A weak substitute provides a lower level of
satisfaction than the substituted good or service. An
example of a weak substitute for mangoes is rice cake
when used as dessert during meals.
THE BUDGET LINE
The budget line is a useful tool in determining the
combinations of goods and services that will satisfy
the consumer with a limited income or budget to
spare.
The budget line may be defined as “the line on a
diagram that shows the various combinations of
commodities that can be bought with a given income
at a given set prices.”