What is Utility?

Product angle: Want satisfying property of any product

(absolute).

Consumer angle: The psychological feeling of

satisfaction or happiness or well being or benefit

derived by the consumer by the consumption of

certain units of a good or service at a certain point of

time (subjective).

Utility can be measured in two ways:

Cardinal Utility:Assigning numerical values to the amount

of satisfaction

Ordinal Utility:: Not assigning numerical values to the

amount of satisfaction but indicating the order of preferences,

that is, what is preferred to what

Utility is of two types:

Total Utility Marginal Utility

Total Utility

• Sum of utility derived by consumer from multiple units

consumed

• at a point or over a period of time

• Example: A consumer consumes 3 units of X and

• derives utility u1, u2, u3 and u4

• Total Utility Ux= u1 + u2 + u3

Total Utility

• The total satisfaction of wants & needs obtained from the consumption of goods & services

• Based on the presumption that the amount of utility generated from the consumption of a good can be explicitly measures

• Hypothetical measure is util

Marginal Utility

The change in total utility (TU) derived from

• one additional unit of consumption (X)

MU = TU/ X

Table : Total Utility (TU) and Marginal Utility (MU)

Ice-creams Consumed

Total Utility (TUx)

Marginal Utility (MUx)

1 20 20

2 36 16

3 46 10

4 50 4

5 50 0

6 44 -6

• The first column is showing the unit of a commodity. Second column of the above table gives and individuals hypothetical total utility (tu) from consuming various alternative quantities of commodity X . There it is noted that, as the individual consumes more unit of X, Tux increases.

• The Third column of the table is showing the individuals marginal Utility for commodity X. each value of column three is obtain by subtracting two successive value of column two. For example, If the individuals consumption of X goes from 1 unit to 2 units, the (tux ) goes from 20 to 36 utilities, giving a MUx of 16. Similarly if the consumption of X rises from 2 units to 3 units, the (Tux) rises from 36 to 46, giving a MUx from 16 to 10. From the table we can see that as this individuals consumption more Units of X, MUx falls.

Total Utility and Marginal Utility curve

• In Fig, units of ice-cream, are shown along the X-axis and TU and MU are measured along the Y-axis. MU is positive and TU is increasing till the 4th ice-cream. After consuming the 5th ice-cream, MU is zero and TU is maximum.

• This point is known as the point of satiety or the stage of maximum satisfaction. After consuming the 6th ice-cream, MU is negative (known as disutility) and total utility starts diminishing. Disutility is the opposite of utility. It refers to loss of satisfaction due to consumption of too much of a thing.

Basic Assumptions of Marginal Utility Analysis

(i) Cardinal Measurement of Utility(ii) Utilities are Independent(iii) Constant Marginal Utility of Money(iv) Introspection

• (i) Cardinal Measurement of Utility: Marginal utility analysis assumes in the first place that utility can be measured and the exact measurement can be given by assigning definite numbers such as 1, 2, 3, etc. That is, it is assumed that utility is a quantifiable entity.

• (ii) Utilities are Independent: Marginal utility analysis assumes that the utilities of different commodities are independent of one another. That is, the utility of one commodity does not in any way affect that of another.

• (iii) Constant Marginal Utility of Money: Another important assumption of the marginal utility analysis is that the marginal utility of money remains constant even though the quantity of money with the consumer is diminished by the successive purchases made by him.

• (iv) Introspection: The Marginal Utility analysis also assumes that from one’s own experience (judging what happens in one’s own mind), it is possible to draw inference about person. This is self-observation applied to another person.

Law of Diminishing Marginal Utility

• “As the quantity consumed of a commodity goes on increasing, the utility derived from each successive unit goes on diminishing, consumption of all other commodities remaining the same” When the changes in consumption are infinitely small, marginal utility is the derivative of total utility.

MU = dTU/dX

Law of Diminishing Marginal Utility

-20

-10

0

10

20

30

40

50

60

70

1 2 3 4 5 6

total utility

marginal utility

Example

As an example assume you have one ice cream

1 Ice Cream you feel Ecstatic

You have a second Ice cream

2nd Ice Cream, u still feel Ecstatic

You have the third Ice cream

3rd Ice Cream You Feel Very Happy

You have the fourth Ice Cream

4th Ice Cream You Feel Happy

You have the fifth Ice Cream,

5th Ice Cream You Still Feel Happy

You have the sixth Ice Cream

6th Ice Cream You are not so Happy

You have the seventh Ice Cream

7th Ice Cream You are not so Happy

You have the eighth Ice Cream

8th Ice Cream You fall sick

The following table will make the law of diminishing marginal utility more clear

Units Total Utility Marginal Utility1st ice cream 20 202nd ice cream 32 123rd ice cream 40 84th ice cream 44 45th ice cream 45 16th ice cream 45 07TH ice cream 42 -38th ice cream 40 -5

Conclusion

• We can say that the law of diminishing utility, like other laws of Economics, is simply a statement of tendency. It holds good, provided other factors remain constant.