What is Utility???What is Utility???

Psychological feeling of satisfaction, pleasure,

happiness which is derived from consumption,

possession or the use of a commodity is known as

utility.

Concept of UtilityConcept of Utility

Commodity AngleCommodity Angle

Consumer’s AngleConsumer’s Angle

Difference….Difference….

Commodity AngleCommodity Angle

Utility is the want satisfying Utility is the want satisfying property of a commodityproperty of a commodity ..

Utility is absolute & ethically Utility is absolute & ethically neutral in nature.neutral in nature.

Utility does not depend on Utility does not depend on the person using the the person using the commodity.commodity.

Consumer’s AngleConsumer’s Angle

Utility is the psychological Utility is the psychological feeling of satisfaction feeling of satisfaction from possession, from possession, consumption or use of a consumption or use of a commodity.commodity.

Utility is a post-Utility is a post-consumption consumption phenomenon.phenomenon.

Utility varies from person Utility varies from person to person and time to to person and time to time.time.

Cardinal utility Ordinal utility 1.Utility is cardinally

or quantitatively measurable like weight, height, length, temperature and air pressure.

2.Utility can be assigned a cardinal number like 1, 2, 3 and so on.

1.Utility is not quantitatively measurable. No absolute terms can be assigned.

2.It can be measured only in relative terms or in terms of ‘less than’ or ‘more than’.

CONCEPTS OF UTILITY

Definitions…Total Utility: Sum of the utilities derived by a consumer from the various units of goods and services he consumes is called the total utility or TU.

Marginal Utility: Addition made to total utility resulting from the consumption of one additional unit is called as marginal utility or MU.

(MUn=TUn-TUn-1)

Cardinal Utility Cardinal Utility Approach of Consumer Approach of Consumer

Behavior can be studied Behavior can be studied under:under:

Law of Diminishing Marginal Utility

Law of Equimarginal Utility

The Law of Diminishing The Law of Diminishing Marginal UtilityMarginal Utility

As the quantity consumed of a commodity increases, the utility

derived from each successive unit decreases, consumption of all

other commodities remaining the same.

No of units consumed

Total utility Marginal utility

1 12 12

2 22 10

3 30 8

4 36 6

5 40 4

6 40 0

7 38 -2

8 35 -5

Total and Marginal utility schedules

TU

MUQUANTITY

TU &

MU

Diminishing marginal utility

Why MU decreases???Why MU decreases???

When a consumer consumes additional units of a

particular good at a point of time, his desire for every successive unit becomes less intense, consequently utility derived from each successive

unit diminishes.

Assumptions to the law of Assumptions to the law of Diminishing Marginal UtilityDiminishing Marginal Utility

Various units of the goods are homogenousVarious units of the goods are homogenous

There is no time gap between consumption There is no time gap between consumption of different unitsof different units

Consumer is rational (has complete Consumer is rational (has complete knowledge and maximizes utility)knowledge and maximizes utility)

Tastes, preferences and fashions remain Tastes, preferences and fashions remain unchangedunchanged..

Cardinal Utility ApproachCardinal Utility Approach

What is consumer equilibrium?What is consumer equilibrium?

A consumer is said to have reached his A consumer is said to have reached his equilibrium position when he has maximized equilibrium position when he has maximized the level of his satisfaction with the available the level of his satisfaction with the available resources .resources .

A rational consumer consumes commodities A rational consumer consumes commodities in the order of their utilities and switches his in the order of their utilities and switches his expenditure from one commodity to the other expenditure from one commodity to the other as per their utilities.as per their utilities.

Continued…Continued…

When he reaches the stage When he reaches the stage when he no more shifts from when he no more shifts from

one commodity to the other, it one commodity to the other, it is known as is known as consumer’s consumer’s

equilibrium.equilibrium.

Consumer equilibriumConsumer equilibriumA consumer is said to be in

equilibrium (i.e. gets maximum satisfaction) if he consumes up to

the point where the marginal utility of each unit of good equals

per unit expenditure i.e MUx=Px(Mum)

AssumptionsAssumptionsRationalityRationality

Limited money incomeLimited money income

Maximization of satisfactionMaximization of satisfaction

Utility is cardinally measurableUtility is cardinally measurable

Diminishing Marginal UtilityDiminishing Marginal Utility

Continued…Continued…

Constant Marginal Utility of moneyConstant Marginal Utility of money

Utility is additiveUtility is additive

Principle of Equi-Marginal utilityPrinciple of Equi-Marginal utility

The law of Equi-Marginal Utility states that the consumer will distribute his money income between the goods in such a way that the utility derived from the last rupee spent on each good is equal.

MUx

Px= MUm

Where MUm= marginal utility of money expenditure

MUx= marginal utility of good X

Px= price of X

Marginal Utility Of Goods X & YMarginal Utility Of Goods X & Y

UNITSUNITS MUx (utils)MUx (utils) MUy (utils)MUy (utils)

11 2020 2424

22 1818 2121

33 1616 1818

44 1414 1515

55 1212 1212

66 1010 99

Let the prices of goods X & Y be RS. 2 & Rs. 3 respectively. Dividing MUx by 2 and MUy by 3 we get the following table.

Again assume that the income of the consumer is Rs.24 to be spent on the two goods.

When will be the consumer in equilibrium ?

Marginal Utility Of Money Marginal Utility Of Money ExpenditureExpenditure

UNITSUNITS MUx/PxMUx/Px MUy/PyMUy/Py

11 1010 8

22 99 7

33 8 6

4 7 5

5 6 44

6 5 33

Thus the consumer will be in equilibrium when he is buying 6 units of good X and 4 units of good Y and will be spending:

(Rs. 2 * 6+ Rs. 3 * 4) = Rs.24.

Thus in equilibrium position:MUxMUx

Px=

MUy

PyMUm=

MU 3 >

MU 4 >

MU 5 > Px (MUm)

MU 6 = Px(Mum)

MUx

3 4 5 6

P

QUANTITY OF GOOD X

MA

RG

INA

L U

TIL

ITY (

Rs)

Px (Mum)

Consumer Equilibrium

Px (Mum)

Px (Mum)