UTILITY ANALYSIS

Presented By: Ankush Sharma Suman Pahuja Nirbhay Singh

Presented To: Dr. Prerna Sharma

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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

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Cardinal Utility Vs Ordinal Utility Cardinal

Assigning numerical values to the amount of satisfaction

Ordinal Not assigning

numerical values to the amount of satisfaction but indicating the order of preferences, that is, what is preferred to what

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Characteristics Subjective Relative Not Essentially Useful Independent of Morality

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Types of Utility Initial Utility

It is obtained from the consumption of the first unit of a commodity

Total Utility Tux = f (Qx)

Marginal Utility MUnth = Tn – Tn-1 or MU = change TU/

change Q

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Relation between Total Utility and Marginal

Utility:Quantity Total

UtilityMarginal

UtilityDescription

0 0 - Initial Utility1 8 8 – 0 = 82 14 14 – 8 = 6 Positive Utility3 18 18 – 14 = 44 20 20 – 18 = 25 20 20 – 20 = 0 Zero Utility6 18 18 – 20 = -2 Negative

Utility

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X

Marginal Utility

Total Utility

X1 X2

X1 X2

Graphs of Total Utility &

Marginal Util ity

X

TU

MU

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.

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.

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Laws of Utility Analysis

Law of Diminishing Marginal Utility Law of Equi-Marginal Utility

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Law of Diminishing Marginal

UtilityThis law can be stated as the fall in marginal utility of any good due to successive consumption of that good.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.

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1 2 3 4 5 6 7 8

-20

-15

-10

-5

0

5

10

15

20

It can also be shown by graph

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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.

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No. of Ice Cream Cups

Marginal Utility

First 4Second 3Third 2

Fourth 1Fifth 0Sixth -1

Table Shows:The table shows that first cup of ice cream yields 4utils of marginal utility.The second cup of ice cream will yield less marginal utility than the first one i.e. 3utils.Third cup will yield still less MU, say 2utils.Fourth cup will yield just 1utils of MU. At this stage want may be fully satisfied. Thus fifth cup will yield zero MU. If you are forced to take sixth cup of ice cream it may upset system and yields negative utility say, -1 util.

1 2 3 4 5 6

4

3

2

1

0

In the Figure:OX axis – Ice Cream(Quantity)OY axis – Marginal Utility(MU)AB is Marginal Utility Curve (MUC)It slopes downward from left to right (negative slope) indicating first cup of ice cream 4 utils, second 3 utils, third 2 utils and fourth 1util of marginal utility. Fifth cup of ice – cream yields zero marginal utility.AB curve touches OX – axis at point C that represents fifth cup of ice cream.sixth cup of ice cream yields negative marginal utility and so AB curve goes below OX – axis.

A

B-1

X

Y

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AssumptionsUtility 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 same quality and size.There is a continuous consumption of commoditySuitable quantity of a commodity is consumed.There is no change in the income of consumer.There is no change in the price of commodity and its substitutes.There is no change in the tastes, character, fashion, and habits of consumer.

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Criticism of utility analysis

Utility is subjectiveCardinal measurement of Utility is not possible Every commodity is not an independent commodity Marginal utility cannot be estimated in all conditions Marginal utility of money does not remain constantToo many assumptionsconsumer is regarded as computer It does not explain giffen’s paradox

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Consumer Surplus

It was first introduced by Marshall.Consumer surplus measures the difference between what a person is prepared to pay for a commodity and the amount that he actually is required to pay.

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Example: Let us suppose that a cutomer is willing to pay a price of p2 for a q2

quantity of goods and likewise for q 1a price of p1, but in actual the market price of that good is p0 and he can purchase q0 quantity of that good on demand curve DD’. Therefore that area between A&C represents the consumer ‘s surplus.

D

D’

Consumer’s SurplusA

C

qq0q1O

p1

p0

Price

q2

r1r2

Bp2

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