Elements of Economic Cycle

Production --- Production Possibility Model

Distribution ------ Demand and Supply Analysis

Consumption---- Satisfaction by consuming any G&S

UTILITY ANALYSIS
Utility

The term utility in economics is used to

denote that quality in a commodity or
service by virtue of which our wants are
satisfied.
In other words, want – satisfying power
of a good is called utility.
Utility is measuring the satisfaction of a
consumer by consuming any good or
service.
Cardinal Utility Vs Ordinal Utility
Cardinal
Ordinal
 Assigning numerical values  Not assigning numerical
to the amount of satisfaction values to the amount of
 Or Satisfaction is measured satisfaction but indicating
in terms of numbers or digits. the order of preferences, that
is, what is preferred to what.

1 2 3 4 5
Poor Very Good
Cardinal Approach of Utility
According to Prof. Marshall, the utility of a commodity can
be expressed through Cardinal Numbers like 1,2,3,4 etc.
Types of Utility
1. Total Utility TU = f (QA)
Total utility is the total satisfaction obtained from all units
of a particular commodity consumed over a period of time".
2. Marginal Utility MU
Marginal utility is the change in the total utility that results
from unit one unit change in consumption of the commodity
within a given period of time".
Assumptions of Cardinal Utility Analysis
The main assumption or premises on which the cardinal
utility analysis rests are as under.
(i) Rationality. The consumer is rational. He seeks to
maximize satisfaction from the limited income which is at
his disposal.
 
(ii) Utility is cardinally measurable. The utility can be
measured in cardinal numbers such as 1, 3, 10, 15, etc.
The utility is expressed in imaginary cardinal numbers
tells us a great deal about the preference of the
consumer for a good.
(iii) Marginal utility of money remains constant. Another
important premise of cardinal utility of money spent on
the purchase of a good or service should remain
constant.
(iv) Diminishing marginal utility. It is also assumed that
the marginal utility obtained from the consumption of a
good diminishes continuously as its consumption is
increased.
(v) Limited Resources (Money): The consumer has
limited money to spend on the purchase of goods and
services and thus this makes the consumer buy those
commodities first which is a necessity.
Calculation of Utility
Total Utility
TU = f (QA)
Marginal Utility
Mu = ∆TU
                      ∆Q
Marginal utility can be defined as the change in the total
utility resulting from a one-unit change in the
consumption of a commodity per unit of time.
Cardinal Utility Approach
The basic question that we have to find out in utility
analysis is:
 What is maximum satisfaction point of a consumer?
0r
- What is the equilibrium point of a consumer in
cardinal approach.
Cardinal Utility Approach
To find out he answer of these question we have two
cases.
Case I : A consumer consumes one product at one
time
Case II: A consumer consumes two or more than two
products at one time.
Case I: one product at one time
MU=∆TU/∆Q
                   
Q ($)TU ($) MU
0 0
1 40 40
2 85 45
3 120 35
4 140 20
5 150 10
6 157 7
7 160 3
8 160 0
9 155 -5
10 145 -10
Why Marginal utility is declining continuously?
Because of the Law of Diminishing Marginal utility.
This law states that “As a consumer consumes more and more
units of a specific commodity, the extra utility or satisfaction goes
on diminishing or declining”.
For ex:- Suppose a person starts eating toast, the first toast
gives him great pleasure. By the time he taking second he yield
less satisfaction ;the satisfaction of third is less than that of
second and so on. the additional satisfaction goes on
decreasing with every successive toast till it drops down to
zero; and if the consumer forced to take more the satisfaction
may become zero.
Explanation and Example of Law of Diminishing
Marginal Utility:
 
This law can be explained by taking a very simple example.
Suppose a man is very thirsty.
He goes to the market and buys one glass of water. The
glass of water gives him immense pleasure or we say the first
glass of water has great utility for him.
If he takes second glass of water after that, the utility will be
less than that of the first one. It is because the edge of his
thirst has been blunted to a great extent. If he drinks third
glass of water, the utility of the third glass will be less than
that of second and so on.
The utility goes on diminishing with the consumption of
every successive glass of water till it drops down to zero.
This is the point of satiety. It is the position of
consumer’s equilibrium or maximum satisfaction.
If the consumer is forced further to take a glass of
water, it leads to disutility causing total utility to decline.
The marginal utility will become negative.
Now questions arises What is the Maximum
Satisfaction point for a consumer where he stops his
consumption.
That point is Called “Saturation Point”
The equilibrium point for the case I is Saturation point.
Saturation is there
where
TU = Maximum
And MU = zero
In our above example if consumer consumes 8th unit that
is his maximum satisfaction point or equilibrium point.
Q: Find out Consumer’s Eq. point
Q TU
1 20
2 35
3 45
4 50
5 50
6 45

Calculate MU and Make graph and find out saturation point

both in table and graph.
Case II: Two or More than two products at
one time
To find out the equilibrium point in this case there is
Law of Equi- Marginal Utility.
Law of equi – marginal utility is the second important
law of utility analysis.
It states that in order to get maximum satisfaction,
consumer should spend his limited income on
different commodities in such a way that the last rupee
spent on each commodity yield him equal marginal
utility.
Utility Maximizing Rules
MUA MUB
--------- = ----------
PA PB
When the marginal utilities respect to their prices
of the two commodities are equalized , the total
utility is then maximum, which is called consumer
equilibrium point in cardinal approach.
The law of substitution can be explained with the
help of an example.
Example: Suppose consumer has 6 Rupees that he
wants to spend on apples and bananas in order to
obtain maximum total utility and the price for both
goods are Rs1. The following table shows marginal
utility (MU) of spending additional dollars of income
on apples and bananas:
Table 2 PA = 1 Rs PB = 1 Rs Income : 6 Rs
MU of
(Q(Units MU of A
B
)
1 10 8
2 9 7
3 8 6
4 7 5
5 6 4
6 5 3
In order to obtain max satisfaction point there are two
conditions that must be fulfilled:
1. MUA = MUB
PA PB

2. All income should be spent.

Now from the above table 2 we will analyze these points.

First step is to calculate MUA and MUB
PA PB
PA = 1 Rs PB = 1 Rs

Q MUA MUB MUA/ PA MUB/PB

1
10 8 10 8
2
9 7 9 7
3
8 6 8 6
4
7 5 7 5
5
6 4 6 4
6
5 3 5 3
Second step is to find out that equation in the table.
MUA = MUB
PA PB
At 8 =8 this equation is equal
Now we have to see the second condition which shows
all income must be spent which is 6 Rs.
So at 8=8 the consumer is consuming 3 unit of A and 1
unit of B.
Now how much he ha spent; PA is 1 Rs so he spent 3
Rs on Apples and PB is 1 Rs , so he spent 1 Rs on
Bananas.
Total 3+ 1= 4 Rs and remaining income is 2 Rs that
violates the second condition.
So we move on further finding another point which
fulfill both conditions.
Now at 7 = 7 again we find first condition.
But does all income spend now?
At 7 = 7 consumer is consuming 4 units of Apples and
2 units of Bananas
Thus 4 Rs on A and 2 Rs on B total 6 Rs which fulfill
the second condition also.
Now conclude all the discussion ;
By consuming 4 units of Apples and 2 units of
Bananas that person is on its maximum satisfaction
because all of his income (6 Rs) is spent and his MU of
A and B with respect to its prices are also equal (7 = 7)
Question: Find out consumers Max satisfaction point.
Income = 35 Rs
PX = 4 Rs PY = 5 Rs
Reference Material
Economics – Paul Samuelson – 19th Edition – page
number 84- 88
Video links
https://www.youtube.com/watch?v=8Xu6kfjJ-nA

https://www.youtube.com/watch?v=agjQoWXBIHE