Marginal Utility
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Transcript of Marginal Utility
Consumer’s Behavior
Marginal Utility Analysis
Learning Objectives
define total utility and marginal utilityunderstand law of diminishing marginal utilitydescribe relationship between total and marginal utilitydemonstrate demand curvedefine marginal utility of moneyillustrate consumer equilibrium
Two Questions in Consumer’s Behavior
The first one is: why does a consumer demand a good or service.
The second question: how should a consumer spend his limited income on different goods and services
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The problem of a consumer consists of three things:
1. the object
2. the constraints
3. the decision variable44
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Object – To maximize total utility (Satisfaction)
Constraint – Limited Resources (Income)
Decision Variable – The quantity purchased using limited resources
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The principle assumption upon which the theory of consumer behavior and demand is built is:
a consumer attempts to allocate his/her limited money income among available goods and services so as to maximize his/her utility (satisfaction).
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Theories of Consumer Choice
The Cardinal TheoryUtility is measurable in a cardinal sense
The Ordinal TheoryUtility is measurable in an ordinal sense
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What is Utility?Satisfaction, happiness, benefit
What is Util?A unit of measure of utility
Initial Utility
The utility derived from the first unit of a
commodity is called initial utility. It is always positive.
Total UtilityThe total satisfaction derived from the consumption of all the units of a commodity. Consumption of “n” units of commodity, then the total utility (TU)
TUn = U1 + U2 + U3 + ……….. +Un OR TUn =MUn
TOTAL UTILITY
Marginal UtilityThe additional satisfaction gained by the consumption of one more unit of something.
MUn = TUn – TUn-1
OR
The change in total utility (TU) resulting from a one unit change in consumption (X).
MU = TU/ X
MARGINAL UTILITY
CALCULATION OF MARGINAL UTILITY
The marginal utility of the 3rd bottle of water = 36 units – 27 units = 9 units.
Part (a) graphs Total Utility from bottled water.
The figure shows total utility and marginal utility.
GRAPHICAL PRESENTATION OF TOTAL UTILITY AND MARGINAL UTILITY
Each bar shows the extra total utility gains from each additional bottle of water — Marginal Utility.
The blue line is Total Utility curve.
Part (b) shows how Marginal Utility from bottled water diminishes
The downward sloping blue line is Marginal Utility Curve.
MARGINAL UTILITY
Marginal utility Positive Marginal Utility
Zero Marginal Utility
Negative Marginal Utility
Positive Marginal Utility
If, by consuming additional units of a commodity,
total utility increases then the marginal utilities of
these units will be Positive
Negative Marginal Utility
If the consumption of an additional unit of a
commodity Causes fall in total utility, it means the
marginal utility of that unit is negative
Zero Marginal UtilityIf the consumption of an additional
unit of a commodity Causes no change in the
total utility, it means the marginal utility of
that unit is negative
Relationship between Total Utility and Marginal Utility
When marginal utility is positive total utility increases
When marginal utility zero total utility is at maximum. It is also known as ‘point of maximum satisfaction’
When marginal utility is negative total utility diminishes.
X
X
Total Utility
Marginal Utility
TU
MU
X1 X2
X1 X2
Graphs of Total Utility & Marginal
Utility
X2 is where total utility reaches its maximum. MU is zero. This is the saturation point or satiation point.After that point, TU falls and MU is negative.
X1 is where marginal utility reaches its maximum. This is where we encounter diminishing marginal utility. The slope of TU has reached its maximum; TU has an inflection point here.
Diminishing Marginal Utility
• Each additional unit of a product contributes less extra utility than the previous unit.
• It is a psychological fact.
Law of Diminishing Marginal Utility The law of diminishing marginal utility
explains the relation between utility and quantity of a commodity.
when a consumer gets more and more units of a commodity, during a particular time, the utility from the successive units will diminish.
Assumptions1. Utility is cardinal2. The consumer is rational3. Constant Marginal Utility of Money4. The consumer’s income is limited and constant5. The tastes and preferences of the consumer remain
unchanged6. Diminishing Marginal Utility7. Consumption of reasonable quantity8. Continuous consumption9. No change in Quality
Utility is CardinalIt is assumed that utility can be measured and a
consumer can express his satisfaction in quantitative terms such as 1, 2, 3, etc.
The Consumer is RationalThe consumer is assumed to be rational who
measures, calculates and compares the utilities of different commodities and aims at maximizing total satisfaction.
Constant Marginal Utility of Money
As a consumer spends money on the commodity, he is left with lesser money to spend on other commodities.
In this process, the remaining money becomes dearer to the consumer and it increases MU of money for the consumer. But, such an increase in MU of money is ignored.
As MU of a commodity has to be measured in monetary terms, it is assumed that MU of money remains constant.
The consumer’s income is limited and constant
It is assumed that income of the consumer and prices of the goods which the consumer wishes to purchase remain constant.
Consumption of reasonable quantity
It is assumed that a reasonable quantity of the commodity is consumed.
Continuous consumptionIt is assumed that consumption should be a continuous process.
For example, if one ice-cream is consumed in the morning and another in the evening, then the second ice-cream may provide equal or higher satisfaction as compared to the first one.
No change in Quality
Quality of the commodity consumed is assumed to be uniform.
A second cup of ice-cream with nuts and toppings may give more.
Independent utilitiesIt is assumed that all the commodities consumed by a consumer are independent.
It means, MU of one commodity has no relation with MU of another commodity.
Further, it is also assumed that one person’s utility is not affected by the utility of any other person.
Consumer’s Equilibrium – A single commodity
Consumer’s equilibrium leads to a situation where a consumer gets maximum satisfaction out of his limited income
He has no tendency to make any change in his existing expenditure pattern.
The consumer is in equilibrium when the marginal utility of a good(x) is equal to its market price (Px).
MUx = Px
The consumer is in equilibrium when the
marginal utility of a good(x) is equal to its market price (Px).
MUx = Px
Supposing, if MUP, there can be two possibilities
MU > PMU < P
Law of Equi - Marginal Utility
• The law of equi-marginal utility explains the behaviour of a consumer when he consumes more than one commodity.
• It explains how the consumer spends his limited income on various commodities to get maximum satisfaction.
Law of Equi - Marginal Utility
The law states that a consumer maximizes his
total utility by distributing his entire income optimally among the various goods
consumed by him.
ASSUMPTIONS
The consumer is rational so he wants to get maximum satisfaction
Cardinal measurement of utility is possible
Marginal utility of money remains constant
The income of the consumer is given and remain constant
ASSUMPTIONS
Fashions, tastes and preferences remain constant
Prices of the commodities are given and remain constant
Consumption takes place at a given time period
Consumer’s Equilibrium – a Several Commodities
When a consumer is consuming several commodities
[suppose there are two goods X and Y] with different prices
simultaneously, he will be in equilibrium at the point
where the utility derived from the last rupee spent on
each is equal.
The position of consumer’s equilibrium thus can be stated in
following ways
The consumer is in equilibrium when the marginal utility of last rupee spent on each commodity is equal
A consumer will be in equilibrium position where the ratios of marginal utilities of goods to the ratios of corresponding prices for each pair of goods are equal.
When a consumer is at equilibrium He maximizes his satisfaction
He spends his entire income
He attains optimum allocation of expenditure
He consumes optimum quantity of each good
Derivation of the Demand Curve
If the marginal utility is measured in monetary units the demand curve for a good(X) is identical to the positive segment of the Marginal utility curve.
Derivation of the Demand Curve
Constancy of the Marginal Utility of Money
This is one of the important assumptions of the marginal utility analysis.
This means, marginal utility of money remains constant throughout when the individual is spending money.
Constancy of the Marginal Utility of Money
Measurement of marginal utility of goods in terms of money is only possible if the marginal utility of money itself remains constant.
If the marginal utility of money varies, it is not possible to correct measurement of the marginal utility of the good.
Marginal Utility of Money and Price change
When the price of a good falls – the real income of the consumer rises – the marginal utility of money will fall.
On the other hand, when the price of a good rises – the real income of the consumer falls – the marginal utility of money will rise.
But Marshall ignored this and assumed that marginal
utility of money did not change as a result of price
change. Due to this assumption Marshall ignored the income effect of the
price change
Marshall could not provide a satisfactory explanation of ‘Giffen Paradox’
Due to this assumption marginal utility curve becomes the demand curve of the good.
Demerits of Marginal Utility Analysis Cardinal measurement is unrealistic
Assumption of constant marginal utility of money is not valid.
Cardinal utility analysis does not split up the price effect into substitution and income effect.
Marshall could not explain Giffen Paradox.
Cardinal utility analysis assumes too much and explains little.