Utility Analysis
What is Utility?
The want satisfying power contained in a good
is said to be its utility.
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.
Utility can be measured in two ways:
Cardinal Utility:Assigning numerical values to the amount of
satisfaction. The numbers 1, 2, 3, 4 are cardinal numbers.
Ordinal Utility:: Not assigning numerical values to the
amount of satisfaction but indicating the order of preferences, that is,
what is preferred to what. The numbers 1st, 2nd, 3rd, and 4th, are
ordinal numbers.
Assumptions
1. Utility can be measured in the cardinal number system.
2. No small units are consumed
3. Consumer’s taste/preference must remain same during
period of consumption
4. There must be continuity in consumption
5. Mental condition of the consumer must remain normal
during the period of consumption
4
Utility is of two types:
-Total Utility (TU)
-Marginal Utility (MU)
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
Marginal Utility
The change in total utility (TU) derived from
one additional unit of consumption (X)
MU = TU/ X
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
Zero Marginal Utility
If 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 zero.
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
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”
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
14
You have the third Ice cream
3rd Ice Cream You Feel Very Happy
15
You have the fourth Ice Cream
4th Ice Cream You Feel 16
Happy
You have the fifth Ice Cream,
5th Ice Cream You Still Feel
Happy
17
You have the sixth Ice Cream
6th Ice Cream You are
not so Happy
18
You have the seventh Ice Cream
7th Ice Cream You are
not so Happy 19
You have the eighth Ice Cream
8th Ice Cream
You fall sick
20
The following table will make the law of
diminishing marginal utility more clear
Units Total Utility Marginal Utility
1st ice cream 20 20
2nd ice cream 32 12
3rd ice cream 40 8
4th ice cream 44 4
5th ice cream 45 1
6th ice cream 45 0
7TH ice cream 44 -1
8th ice cream 42 -2
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.
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
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
Thank you !!!
