Chapter 4: Utility

• In the words of Hibbdon , “Utility is the Quality of a good to

satisfy a want.”
• Thus we can say that wants satisfying power of a commodity
is called utility.
Key Difference between Cardinal Utility and Ordinal Utility:

• Cardinal Utility is a utility that determines the satisfaction of a commodity used by an

individual and can be supported with a numeric value. On the other hand, Ordinal Utility
defines that satisfaction of user goods can be ranked in order of preference but cannot be
evaluated numerically.
• The measuring term for cardinal and Ordinal Utility is utils and ranks respectively. Utils is the
unit of utility and ranks determine the preference of a product compared to other products in
the market.
• Ordinal Utility measures the utility of goods subjectively, but Cardinal Utility evaluates
objectively.
• Cardinal Utility is not much realistic as compared to the Ordinal Utility as quantitative
evaluation of utility is not practicable. Ordinal Utility depends on qualitative measurement,
which makes it more realistic.
• Another difference between ordinal and Cardinal Utility is that the former one is based on
indifference curve analysis, and the latter is based on marginal utility evaluation.
• Alfred Marshall and his admirers presented the Cardinal Utility approach, and Hicks and Allen
pioneered the Ordinal Utility idea.
Short Note:
• Marginal utility is the added satisfaction a consumer gets from
having one more unit of a good or service. The concept of marginal
utility is used by economists to determine how much of an item
consumers are willing to purchase. The law of diminishing marginal
utility is often used to justify progressive taxes. (A progressive tax is a
tax in which the tax rate increases as the taxable amount increases.)
• An indifference curve shows a combination of two goods in various
quantities that provides equal satisfaction (utility) to an
individual. It is used in economics to describe the point where
individuals have no particular preference for either one good or
another based on their relative quantities.
Features
• UTILITY IS SUBJECTIVE: It is subjective because it deals with the mental satisfaction of
a man.
• UTILITY IS RELATIVE: Utility of a commodity never remains the same. E.g. Cooler has
utility in the summer but not during winter.
• UTILITY IS NOT ESSENTIALLY USEFUL:A commodity having utility need not be useful.
Liquor and cigarette are not useful, but to satisfy the want of an addict then they
gave utility for him.
• UTILITY IS INDEPENDENT OF MORALITY: Utility has nothing to do with morality.
Concepts of Utility
• INITIAL UTILITY: The utility derived from the first unit of a commodity is
called initial utility. It is always positive.

• TOTAL UTILITY: It is the sum total of utility derived from the consumption of
all units of a commodity.

• MARGINAL UTILITY: Marginal means change. It refers to the additional utility

obtained due to the consumption of an additional unit of a commodity.

• Marginal utility can be (i) positive (ii) zero (iii) negative.

RELATION BETWEEN TOTAL UTILITY
AND MARGINAL UTILITY
• LAW OF DIMINISHING MARGINAL UTILITY: It stated that as the consumer goes on
consuming more and more amount of commodity the marginal utility of the
commodity goes on declining becomes zero and finally becomes negative.

• As we go on consuming more and more amount of commodity. The marginal utility

derived from it is declining becomes zero and negative.

• Total utility is increasing at increasing rate so long as marginal utility is positive.

• Total utility becomes maximum when marginal utility is zero.

• Total utility starts declining when marginal utility is negative.

EXAMPLE
UNTIS TOTAL UTILITY MARGINAL
UTILITY
1 8 8
2 14 6
3 18 4
4 20 2
5 20 0
6 18 -2
 TU is maximum
Y

Saturation point
TU

0
X
Y

MU
MU +ve
MU = 0

0 X
MU (–)ve
LAW OF DIMINISHING MARGINAL UTILITY

• It states that as the consumer goes on consuming more and

more amount of the commodity, the marginal utility of the
commodity goes on declining becomes zero and finally becomes
negative.

• E.g. If you are set to buy,say, fountain pens at any given time,
then as the number of pens with you goes on increasing, the
marginal utility from each successive pen will go on decreasing.
ASSUMPTIONS
• Utility can be measured in the cardinal number system.
• Marginal utility of money remains constant.
• Marginal utility of every commodity is independent.
• Every unit of the commodity being used is of the same quality and
size.
• There is a continuous consumption of the commodity.
• Suitable quantity of the commodity is consumed.
• There is no change in the income of the consumer, price of the
commodity, and its substitutes.
• There is no change in the tastes, character, fashion, and habits of
consumers.
 EXPLANATION
TABLE SHOWING LAW OF DIMINISHING MARGINAL UTILITY

No. of ice cream cups Marginal Utility

First 4
Second 3
Third 2
Fourth 1
Fifth 0
Sixth -1
 M.U.
Y
CURVE

• It is evident from the A

4 Point of
table and diagram that +ve
saturation

UTILITY
first cup of ice cream 3
yield 4 utils thus higher 2 Zero
satisfaction and with 1 M.U.
consumption of more O
C
X
and more units of ice -1
1 2 3 4 5 6
-ve
cream, MU from each QUANTITY
B
successive unit goes on
diminishing.
EXCEPTIONS
• Curious and Rare Things: Law does not affect these things. Those
persons who collect old and rare coins, postage stamps, etc derive
increasing marginal utility as the stock of these rare articles goes on
increasing.
• Misers: It seems as if the law does not apply to misers, who are out to
acquire more and more of wealth. Their desire for money seems to be
insatiable.
• Good Book or Poem: Reading a good book or listening to a melodious
song or beautiful poem again and again, one gets more utility than
before so these also exceptions to this law.
 CAUSES OF ITS APPLICATIONS

• Commodities are Imperfect Substitutes: tea in place of

coffee and coffee in place of tea cannot be used to unlimited
extent.
• Stability of particular want
• Alternative uses: Each and every commodities have more
than one uses.
IMPORTANCE OF THE LAW
• Basis of the Laws of Consumption: Law of diminishing marginal utility is the basis of all laws of
consumption.(1) Law of equi -marginal utility.(2)Law of demand and (3) Concept of Consumer’s
Surplus.
• Variety in Production and Consumption: It is because of the operation of law of diminishing
marginal utility. Continuous consumption of one commodity will yield less and less M.U. to the
consumer. So the producers will have to produce different varieties of goods.
• Basis of progressive taxation : In this direct taxes come.
• Advantage to the consumer: Due to law of diminishing M.U a consumer always buys till that
point where P=M.U.
• Difference between Value-in Use and Value-in-Exchange.
• Price Determination
• Basis of re– distribution.
• Examples of the Law of Diminishing Marginal Utility in Business
• Businesses can use this principle to structure their workforce. For example, a company may benefit from
having three accountants on its staff. If there is no need for another accountant, hiring another accountant
results in a diminished utility, as there is a minimum benefit gained from the new hire. However, if you have
two accountants but no one to process paperwork, hiring a new administrative assistant has a higher level of
utility than hiring a third accountant.
• The law of diminishing marginal utility can also affect what goods and services businesses offer to
customers, as it encourages a certain level of diversification. In the above example with the pizza, if the
consumer knows they won't want the fourth or fifth slice of pizza, they might not buy them in the first place.
But they may see a high level of utility in a different food, such as a salad. By diversifying its menu, the shop
selling pizza can avoid diminished marginal utility and encourage consumers to purchase more.
• How the Law Affects Pricing
• The law of diminishing marginal utility affects how businesses price their goods and services. Because the
first quantity of something has the most utility, consumers are usually willing to pay more for it.
• For example, a store might have a deal on backpacks for sale: one backpack for $30, two for $55, or three
pairs for $75. A person buying backpacks can get the best cost per backpack if they buy three.
• Not all buyers will want three backpacks, even though they are the best deal. However, anyone who is
shopping for backpacks needs at least one, so the first backpack has the highest price. After that, because the
marginal utility of each additional backpack decreases, the business must decrease the cost per unit in order
to entice shoppers to purchase more units.
Indifference Curve
• An indifference curve is a chart showing various combinations
of two goods or commodities that leave the consumer equally
well off or equally satisfied—hence indifferent—when it comes to
having any combination between the two items that is shown along
the curve.
• Properties of an Indifference Curve:
• 1. The indifference Curve Slops downwards to the right,
• 2. Indifference Curve in Convex to the origin.
• 3. indifference curve do not intersect.
• 4. The higher the indifference curve represents the higher the utility.
For instance, if you like both hot
dogs and hamburgers, you may be
indifferent to buying either 20 hot
dogs and no hamburgers, 45
hamburgers and no hot dogs, or
some combination of the two—for
example, 14 hot dogs and 20
hamburgers. Either combination
provides the same utility.