UNIT 7

UTILITYUtility means satisfaction. More precisely, it refers to how consumers rank different goods & services. In economics, utility is measures in Units.TOTAL UTILITYTotal Utility is the total benefit that a person gets from the consumption of goods & services.MARGINAL UTILITYThe expression marginal is a key term in economics and always means additional or extra. Marginal Utility denotes the additional utility you get from the consumption of an additional unit of a commodity.MARGINAL UTILITY = CHANGE IN TOTAL UTILITYCHANGE IN QUANTITY

Darrens utility from consuming crisps (daily)MUDTU = 2DQ = 1MU = DTU / DQ = 2/1 = 2Utility (utils)Packets of crisps consumed (per day)TU

fig

THE LAW OF DIMINISHING MARGINAL UTILITYThis law states that, as the amount of a good consumed increases, the marginal utility of that good tends to diminish. (Law was proposed and developed by A. Marshall)What is the reason for this law?Utility tends to increase as you consume more and more of a good.

However, according to the law of diminishing marginal utility, as you consume more and more, your total utility will grow at a slower rate.

Growth in TU slows because your MU (the extra utility added by the last unit consumed of a good) diminishes as more of the good is consumed.

The diminishing marginal utility results from the fact that your enjoyment of the good drops off as more and more of it is consumed.

1Quantity Of Good Consumed ( Q )2Total Utility ( U )3Marginal Utility ( MU )012345 0 4 7 9101043210

01234551012346789UQTOTAL UTILITY

01234554321MUQMARGINAL UTILITY

EQUIMARGINAL PRINCIPLE / MAXIMIZING UTILITYThe fundamental condition of maximum satisfaction or utility is the equimarginal principle. It states that a consumer having a fixed income and facing given market prices of goods will achieve maximum satisfaction or utility when the marginal utility of the last dollar spent on each good is exactly the same as the marginal utility of the last dollar spent on any other good. MU of good A =MU of good B Price of APrice of BUtility per dollar of the commodity:MUPUtility maximization rule:Utility will be maximized at the point where:

The following table shows the utility schedules of a consumer who devotes his weekly income of $9 to fish and vegetables. The price of fish is $2 per Kg. While the price of vegetables is $1 per Kg. How much should he consume in order to maximize his utility and how much is his maximum utility?Quantity (Kg)

123456

Fish

5080100110115119

Vegetables

304555606263

Total Utility

Quantity of F & V (Kg)

123456

TU of F

5080100110115119

MU of F

5030201054

MU of F P of F

25151052.52TU of V

304555606263

MU of V

301510521MU of V P of V

301510521Units Consumed

1 V1 F1 F1 V1 F1 V3 V , 3 FExpenditure

1221219Units derived for consumption

3050301520101553 units of vegetables and 3 units of fish is being purchased, when the price of fish is $2 and price of vegetables is $1 and the income to be spent is $9

$3$232D for FishQuantityPrice

The Optimal Purchase RulePx = MUxIf marginal utility is greater than price, the consumer can improve her well-being by purchasing more.

If marginal utility is less than price, the consumer can improve her well-being by purchasing less.

The Demand Curve?The demand curve is downward sloping because marginal utility declines.Recall that a utility maximizing consumer always sets P = MULet P rise. Then MU must rise to maintain the equality.Then quantity purchased must fall.Negative relationship between price and quantity demanded.

Demand is Downward sloping

Why is the price of diamonds higher than the price of water?

Why is the price of diamonds is higher than the price of water?The marginal utility approach implies that when one commodity is in abundance, its MU is low as MU is inversely related to Quantity and incase of a scarce commodity the MU is high.

MUWater < MUDiamnonds

No doubt the TUwater > TUdiamonds as humans cannot live without water for more than a couple of days.

But the price of a commodity is determined on the basis of MU and not TU.

ExerciseDifferentiate between TU & MU with the help of an example & a diagram.Why is the price of diamond is higher than the price of water?Define Equimarginal Utility. Calculate equimarginal utility for the given TU below, if the price per unit is $2.

1Quantity Of Good Consumed ( Q )2Total Utility (TU )012345 0 4 7 91010

Q.4. Anita consumes both pizza and Pepsi. The following table shows the amount of utility she obtains from different amounts of these two goods:

Suppose Pepsi costs $0.50 per can, pizza costs $1 per slice, and Anita has $9 to spend on food and drink. What combination of pizza and Pepsi will maximize her utility?

PizzaPepsiQuantityTUQuantityTU4 slices1155 cans635 slices1356 cans756 slices1547 cans867 slices1718 cans96