UTILITY ANALYSIS

Concept of Utility
The term utility refers to the human want satisfying power of the commodity. All those goods
and services which have the capacity of satisfying wants are said to contain utility in
economic point of view. It is the subjective concept and can vary from person to person, time
to time and place to place. In the perspective of moral aspect, cigarette may be a bad but in
economics it can be a good as it provides utility for the consumers who enjoying smoking.
Theories of Utility Analysis
Basically there are two theories related to utility analysis
1. Cardinal utility analysis
2. Ordinal utility analysis
Cardinal Utility Analysis
Cardinal utility analysis is based on the cardinal measurement of utility which assumes that
utility is measurable and additive. This theory was developed by neo-classical economists
like Marshall, Pigou, and Robertson etc. It is expressed as a quantity measured in
hypothetical units which called utils. If a consumer imagines that one mango has 8 utils and
an apple 4 utils, it implies that the utility of mango is twice than of an apple.

Assumptions of Cardinal Utility Analysis

The cardinal utility analysis is based on the following assumptions:
(i) Rationality: In the cardinal utility analysis, it is assumed that the consumer is rational. He
aims at maximization of utility subject to availability of his income.
(ii) Constant marginal utility of money: It is assumed in the theory that the marginal utility
of money based for purchasing goods remains constant. If the marginal utility of money
changes with the increase or decrease in income, it then cannot yield correct measurement of
the marginal utility of the good.
(iii) Diminishing marginal utility: Another important assumption of cardinal utility analysis
is that the utility gained from the successive units of a commodity diminishes in a given time
period.
(iv) Utility is additive: In the early versions of the theory of consumer behavior, it was
assumed that the utilities of different commodities are independent. The total utility of each
commodity is additive.
U = U1 (X1) + U2 (X2) + U3 (X3)………. Un (Xn)
(v) Consumption to be continuous: It is assumed in this law that the consumption of a
commodity should be continuous. If there is interval between the consumption of the same
units of the commodity, the law may not hold good. For instance, if you take one glass of
water in the morning and the 2nd at noon, the marginal utility of the 2nd glass of water may
increase.
(vi) Suitable quantity: It is also assumed that the commodity consumed is taken in suitable
and reasonable units. If the units are too small, then the marginal utility instead of falling may
increase up to a few units.
(vii) No change to fashion: Customs and tastes: If there is a sudden change in fashion or
customs or taste of a consumer, it can than make the law inoperative.
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(viii) No change in the price of the commodity: there should be any change in the price of
that

Types of Utility
1. Total Utility – TU
Total satisfaction obtained by the consumer from consuming all the available units of
the commodity is called total utility. It is the sum of total of all the marginal utilities
associated with each and every unit of consumption. . If continuous units of a commodity
'X' are consumed, then

TUx = ∑ MUx

2. Marginal Utility – MU: Marginal utility means an additional or incremental utility.

Marginal utility is the change in the total utility that results from unit one unit change
in consumption of the commodity within a given period of time. The following
formula may be used to measure it.

Marginal utility = Change in total utility / Change in quantity consumed

or

MU = ∆TU / ∆Q or MU = dTU / dQ

It may here be noted that as a person consumes more and more units of a commodity, the
marginal utility of the additional units begins to diminish but the total utility goes on
increasing at a diminishing rate.

When the marginal utility comes to zero or we say the point of satiety is reached, the total
utility is the maximum. If consumption is increased further from this point of satiety, the
marginal utility becomes negative and total utility begins to diminish.

The relationship between total utility and marginal utility is now explained with the help of
following schedule and a graph.
∆𝑻𝑼
Units of Apple Consumed (Q) Total Utility in Utils TU=∑MU Marginal Utility MU= ∆𝑸
1 7 7
2 11 4 (11-7)
3 13 2 (13-11)
4 14 1 (14-13)
5 14 0 (14-14)
6 13 -1 (13-14)

The above table shows that when a person consumes no apples, he gets no satisfaction. His
total utility is zero. In case he consumes one apple a day, he gains seven units of satisfaction.
His total utility is 7 and his marginal utility is also 7. In case he consumes second apple, he
gains extra 4 utils (MU). Thus given him a total utility of 11 utils from two apples. His

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marginal utility has gone down from 7 utils to 4 utils because he has a less craving for the
second apple. Same is the case with the consumption of third apple. The marginal utility has
now fallen to 2 utils while the total utility of three apples has increased to 13 utils (7 + 4 + 2).
In case the consumer takes fifth apple, his marginal utility falls to zero utils and if he
consumes sixth apple also, the total showing total utility and marginal utility is plotted in
figure below:

Diagram/Curve:

(i) The total utility curves starts at the origin as zero consumption of apples yield zero utility.

(ii) The TU curve reaches at its maximum or a peak of M when MU is zero.

(iii) The MU curve falls through the graph. A special point occurs when the consumer
consumes fifth apple. He gains no marginal utility from it. After this point, marginal utility
becomes negative.

(iv) The MU curve can be derived from the total utility curve. It is the slope of the line
joining two adjacent quantities on the curve. For example, the marginal utility of the third
apple is the slope of line joining points a and b.

Law OF Diminishing Marginal Utility

The law of diminishing marginal utility describes a familiar and fundamental tendency of
human behavior. The law of diminishing marginal utility states that:
“As a consumer consumes more and more units of a specific commodity, the utility from the
successive units goes on diminishing”.
Mr. H. Gossen, a German economist, was first to explain this law in 1854. Alfred Marshal
later on restated this law in the following words:
“The additional benefit which a person derives from an increase of his stock of a thing
diminishes with every increase in the stock that already has”.

Law Is Based Upon Three Facts:

The law of diminishing marginal utility is based upon three facts.

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First, total wants of a man are unlimited but each single want can be satisfied. As a man get
more and more units of a commodity, the desire of his for that good goes on falling. A point
is reached when the consumer no longer wants any more units of that good.
Secondly, different goods are not perfect substitutes for each other in the satisfaction of
various particular wants. As such the marginal utility will decline as the consumer gets
additional units of a specific good.
Thirdly, the marginal utility of money is constant given the consumer’s wealth.
The basis of this law is a fundamental feature of wants. It states that when people go to the
market for the purchase of commodities, they do not attach equal importance to all the
commodities which they buy. In case of some of commodities, they are willing to pay more
and in some less. The more one has of a thing, the less he wants the additional units of it. In
other words, the marginal utility of a commodity diminishing as the consumer gets larger
quantities of it. This, in brief, is the axiom of law of diminishing marginal utility.

Explanation and Example of Law of Diminishing Marginal Utility:

This law can be explained by taking a very simple example. Suppose, a man is very thirsty.
He goes to the market and buys one glass of sweet water. The glass of water gives him
immense pleasure or we say the first glass of water has great utility for him. If he takes
second glass of water after that, the utility will be less than that of the first one. It is because
the edge of his thirst has been blunted to a great extent. If he drinks third glass of water, the
utility of the third glass will be less than that of second and so on. The utility goes on
diminishing with the consumption of each successive glass water till it drops down to zero.
This is the point of satiety. It is the position of consumer’s equilibrium or maximum
satisfaction. If the consumer is forced further to take a glass of water, it leads to disutility
causing total utility to decline. The marginal utility will become negative. A rational
consumer will stop taking water at the point at which marginal utility becomes negative even
if the good is free. In short, the more we have of a thing, ceteris paribus, the less we want still
more of that, or to be more precise.
“In given span of time, the more of a specific product a consumer obtains, the less anxious he
is to get more units of that product” or we can say that as more units of a good are consumed,
additional units will provide less additional satisfaction than previous units. The following
table and graph will make the law of diminishing marginal utility more clear.

Units Total Utility Marginal Utility

1st glass 20 20
2nd glass 32 12
3rd glass 40 8
4th glass 42 2
5th glass 42 0
6th glass 39 -3

From the above table, it is clear that in a given span of time, the first glass of water to a
thirsty man gives 20 units of utility. When he takes second glass of water, the marginal utility
goes on down to 12 units; When he consumes fifth glass of water, the marginal utility drops

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down to zero and if the consumption of water is forced further from this point, the utility
changes into disutility (-3). Here it may be noted that the utility of then successive units
consumed diminishes not because they are not of inferior in quality than that of others. We
assume that all the units of a commodity consumed are exactly alike. The utility of the
successive units falls simply because they happen to be consumed afterwards. The law of
diminishing marginal utility can also be represented by a diagram.

In the figure (2.2), along OX we measure units of a commodity consumed and along OY is
shown the marginal utility derived from them. The marginal utility of the first glass of water
is called initial utility. It is equal to 20 units. The MU of the 5th glass of water is zero. It is
called satiety point. The MU of the 6th glass of water is negative (-3). The MU curve here lies
below the OX axis. The utility curve MM/ falls left from left down to the right showing that
the marginal utility of the success units of glasses of water is falling.

Consumer’s equilibrium through cardinal utility approach: one commodity model

Consumer consumes goods and services to get utility. In cardinal utility approach, the utility
gained by consuming the given units of the commodity in a given period of time can be
expressed in terms of cardinal number which is called total utility (TU). The change in total
utility due to one unit change in the commodity consumed is known as marginal utility (MU).
And the MU diminishes when more and more units of a commodity are consumed. This
process is known as law diminishing marginal utility. Consumer’s equilibrium under one
commodity model can be explained by the help of law of diminishing marginal utility.
The consumer is in equilibrium when he maximizes his total satisfaction given his income
and market prices of the goods consumed. In this model, the consumer should purchase that

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much quantity of a commodity where marginal utility of the commodity in terms of money
becomes equal to the price of the commodity.
Condition for equilibrium
𝑀𝑈𝑥
= 𝑀𝑈𝑚
𝑃𝑥
For simplicity MUm is assumed to be 1.

Hence,
𝑀𝑈𝑥
=1
𝑃𝑥
MUx=Px is the required condition for consumer’s equilibrium. If MUx>Px, the consumer
consumes more quantity of X goods so that finally MUx=Px. On the other hand if MUx<Px,
the consumer consumes less quantities of X goods so that finally MUx=Px.

Let’s examine the consumer’s equilibrium condition by graphically following figure.

MUx>MUm
Marginal utility

E
Px (MUm)

MUx<MUm

MUx

O X
X0 X X1
Units of consumption

In the above figure MUx curve is the marginal utility of X goods which is downward sloping
and indicates that marginal utility of commodity is diminishing. MUm is the marginal utility
of money which indicates marginal utility of money is constant. Left side of point E,
MUx>MUm so consumer consumes more units of commodity X say from X to X 1. At point
E, MUx=Px(MUm). Right side of point E, MUx<MUm so consumer decreases the
consumption of X commodity from X to X0 where MUx=MUm (Px). Hence point E is the
consumer’s equilibrium point.