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CHAPTER 2

CONSUMER BEHAVIOUR

(UTILITY ANALYSIS)

INDEX1 UTILITY

2 FEATURES OF UTILITY

3 TYPES OF UTILITY

4 CONCEPTS OF UTILITY

5 RELATIONSHIP BETWEEN MU AND TU

6 DIMINISHING MARGINAL UTILITY

7 EQUI-MARGINAL UTILITY

UTILITYEvery individual has certain wants and he consumes commoditieswhich lead to the satisfaction of such wants. It means that thecommodities have a capacity to satisfy human wants. Therefore, ingeneral terms, we say that a commodity is useful if it satisfies ourwant.In Economics, the want satisfying power of a commodity is called“utility”. Utility is the capacity of a commodity to satisfyparticular human want.

Also, utility and satisfaction are two different terms but they areinter-related. Utility is pre-consumption and satisfaction is post-consumption. Utility is assumed satisfaction but satisfaction issomething that is actually realized.

UTILITY

UTILITY SATISFACTION

Consumption of goods and services depends on utility. Everyproduct possesses power to satisfy human wants. This innerquality of a commodity which satisfies human wants is called asutility.

UTILITY

UTILITY SATISFACTION• Pre-consumption

• Assumed satisfaction

• Post-consumption

• Something that is actually realized

UTILITY

F - Forms the basis for demand

E - Ethical significance not considered

A - Also different from usefulness

T - The measurement not possible

U - Utility - subjective concept

R - Relative Concept

E - Even different from pleasure

S - Satisfaction and utility are different

U - Utility depends on intensity of the want

FEATURES

F - FORMS THE BASIS FOR

DEMAND

E - Ethical significance not considered








A person will demand acommodity only if it hasutility for him.

FEATURES

F - FORMS THE BASIS FOR

DEMAND

E – Ethically neutral








An uneducated person will notdemand a book as it has no utility forhim. A student will demand a bookas it has utility for him.

FEATURES

A student pursuing Arts will notdemand a calculator as it has noutility for him. A student pursuingCommerce will demand it.


E – ETHICALLY NEUTRAL

A - Also not the same as usefulness







The concept of utility does notconsider whether thecommodity satisfies a goodwant or a bad want. Acommodity can have utilityeven if it satisfies a bad orunethical want. Utility doesnot consider any moral orethical factors. In short, it isethically neutral.

FEATURES


E - ETHICAL SIGNIFICANCE

NOT CONSIDERED








FEATURES

A gun has utility for a soldier as wellas a terrorist.



A - ALSO NOT THE SAME AS

USEFULNESS







FEATURES

Usefulness is the benefit thatis derived by consuming acommodity whereas utility isthe want satisfying power of acommodity. A commodityhaving utility need not beuseful.



A - ALSO NOT THE SAME AS

USEFULNESS







FEATURES

Alcohol has utility to drunkardbut it is not useful as it harmshis health.

Hookahs have utility forcustomers of a hookah bar butit is not useful as it harms theirhealth.




T - THE MEASUREMENT NOT

POSSIBLE






FEATURES

Utility is a psychologicalconcept. It is intangible andinvisible. It is an inherentfeeling. Therefore, it cannotbe measured cardinally i.e. innumbers.




T - THE MEASUREMENT NOT

POSSIBLE






FEATURESIt cannot be said that “GoodDay” biscuit has 5 utility and“Dark Fantasy” biscuit has 10utility.

However, utility can bemeasured in relative terms.

The utility of food is ‘higher’for a person who is hungry and‘lower’ for a person who is nothungry.





U - UTILITY - SUBJECTIVE

CONCEPT





FEATURES“Subjectivity” meanschanging from one person toanother. A product may giveutility to one person but thesame product may not give asmuch utility to another.Therefore, utility is asubjective concept as theutility of a commodity differsfrom person to person onaccount of differences intastes, preference, habits,surroundings, age, occupationetc.





U - UTILITY - SUBJECTIVE

CONCEPT





FEATURESA measuring tape will havemore utility to a tailor ascompared to a cobbler.

A fish curry will have moreutility to a non-vegetarianwhile it may have less utility orno utility at all to a vegetarian.






R - RELATIVE CONCEPT




FEATURES

Utility of a commoditychanges from time to timeand place to place.






R - RELATIVE CONCEPT




FEATURESAquaguard (water purifier) hasmore utility in the rainy seasoncompared to other seasonsbecause the risk of water-borne diseases is high.

A room freshner has moreutility in the bathroom ascompared to the drawingroom.






R - Relative concept

E - EVEN DIFFERENT FROM

PLEASURE



FEATURESUtility and pleasure aredifferent. A commodity mayhave utility but it is notnecessary that itsconsumption will givepleasure to the consumer.

A textbook has utility for astudent but he may not derivepleasure from reading it.








S - SATISFACTION AND UTILITY

ARE DIFFERENT


FEATURESUtility and satisfaction areinter-related but there is adifference. The following aredifference:1. Utility is the want

satisfying power of acommodity i.e. utility isconsidered pre-consumption. Satisfactionis the happiness derivedby the consumer afterconsuming a commodityi.e. it is post-consumption.








S - SATISFACTION AND UTILITY

ARE DIFFERENT


FEATURES2. Utility is assumed

satisfaction butsatisfaction is somethingthat is actually realized.

3. Utility is related to thecommodity whereassatisfaction is experiencedby a person.









U - UTILITY DEPENDS ON

INTENSITY OF THE WANT

FEATURESThe utility of a commoditydepends on the intensity ofthe want. If the want isintense and the commoditysatisfies the want, then theutility of the commodity ishigher.









U - UTILITY DEPENDS ON

INTENSITY OF THE WANT

FEATURESThe utility of notes is higherwhen exams are closer as thewant for notes is intense.

The utility of the fan is highwhen the weather is warmoutside as the want for thefan’s breeze is high.

SMART CODE: PLACE SERVICE ON TIME TO FORM KNOWLEDGE

POSSESSION

TYPES OF UTILITY

PLACE UTILITY

SERVICE UTILITY

TIME UTILITY

FORM UTILITY

KNOWLEDGE UTILITY

POSSESSION UTILITY

When a change in place of a commodity increases its utility, it iscalled as place utility. Place utility is created when goods aretransferred from place of production to place of consumption.Transportation helps to create place utility.

PLACE SERVICE TIME FORM KNOWLEDGE POSSESSION

• The utility of Alphonso mangoes increaseswhen they are transferred from mangofarms to other parts of the country.

• The utility of mobile phones increases whenthey are distributed from manufacturingplants to mobile stores.

Service utility is created when any service is provided by anyperson to other person or group of people.

E.g.:

• Professor taking lectures in a coaching class.

• An advocate giving legal advice to his clients.


When utility of a commodity increases by storing it and makingit available during the time of need, it is called time utility.Warehousing helps to create time utility.

E.g.:

• The utility of umbrellas will increase if they are made availableduring the rainy season.

• The utility of crackers will increase if they are distributedduring the period of Diwali.


Form utility is created by changing the form or shape of goods.The process of manufacturing or processing creates form utility.

E.g.:

• When wood is changed to furniture, its utility increases.

• When tea leaves are processed to tea powder, its utilityincreases.


The utility of a product increases when the user or buyer gainsknowledge about such product. This utility is called asknowledge utility. Advertisements, demonstrations, usermanuals etc. help the user or buyer to acquire knowledge aboutthe product.

E.g.:

• The utility of a washing machine will increase when the userknows about its operation.

• The utility of a computer game will increase when the playerknows all its control keys.


Possession utility is created when the legal ownership andpossession is transferred from one person to another (generallyseller to buyer).

E.g.:

• The cakes in the Monginis cake shop have utility. However, theutility will increase when you place your order for the cake, paythe price and take possession of it.

• The utility of a house will increase once the ownership istransferred from the seller to the buyer.

PLACE SERVICE TIME FORM POSSESSIONKNOWLEDGE

TOTAL UTILITY MARGINAL UTILITY

Sum total of the utilities derived by aconsumer by consuming all possibleunits of a commodity at a point oftimeE.g.: If there are 5 Dairy Milkchocolates, then total utility is the sumtotal of the utilities that are derivedfrom consuming all the five chocolates(one after the other) at a point oftime.

Additional utility derived by theconsumer on consumption of anadditional unit of the commodity

E.g.: Suppose the consumer hasconsumed 2 Dairy Milk Chocolates,the additional utility that he derivedwhen he consumes the 3rd chocolate iscalled as marginal utility.

CONCEPTS OF UTILITY

TOTAL UTILITY MARGINAL UTILITY

CONCEPTS OF UTILITY

TUn = MU1 + MU2 + MU3 + ………. +Mun

There is a direct relation betweena stock of a commodity and totalutility. As the stock of a commoditywith a person goes on increasing,the total utility also increases.Larger the stock, larger is the TU.

Note: The TU goes on increasingtill MU reaches zero. Whenmarginal utility is negative, thetotal utility reduces. Please refer toschedule.

MUn = TUn – TUn-1

There is an inverse relation betweena stock of a commodity and marginalutility. As the stock of a commoditywith a person goes on increasing, themarginal utility decreases. Largerthe stock, lesser is the MU.

RELATIONSHIP : MU & TU

No. of choc. TU MU

1st 10 10

2nd 18 8 (18-10)

3rd 22 4 (22-18)

4th 24 2 (24-22)

5th 24 0 (24-24)

6th 22 -2 (22-24)

2

24

141210

864

16

20

26

18

22

-2-4

1 2 3 4 5 6

.

..

. ..

X

Y

TU and MU curve begin at the same point.The TU curve slopes upwards from left to right.The MU curve slopes downwards from left to right.

. .

..

.


No. of choc. TU MU

1st 10 10

2nd 18 8 (18-10)

3rd 22 4 (22-18)

4th 24 2 (24-22)

5th 24 0 (24-24)

6th 22 -2 (22-24)

2

24

141210

864

16

20

26

18

22

-2-4

1 2 3 4 5 6

..

..

. ..

X

Y

Dis - Utility

When TU curve moves downward,the MU curve goes below zero. Thisindicates dis-satisfaction ordisutility.

. .

..


No. of choc. TU MU

1st 10 10

2nd 18 8 (18-10)

3rd 22 4 (22-18)

4th 24 2 (24-22)

5th 24 0 (24-24)

6th 22 -2 (22-24)

2

24

141210

864

16

20

26

18

22

-2-4

1 2 3 4 5 6

..

..

. ..

X

Y

When TU curve move upwards, theMU curve slopes downwards.When TU curve is at the maximumpoint, the MU is zero (i.e. it touchesthe x-axis).This is the point of satietyor point of maximum satisfaction.

. .

..

Point OfSatiety

Dis - Utility

RELATIONSHIP : MU & TU From the above schedule, it can be observed that:1. After the first chocolate is consumed, the TU

and MU are the same.2. As the consumer consumes more chocolates,

the TU goes on increasing from 10 to 18 to 22to 24 while the MU goes on decreasing from 10to 8 to 4 to 2. TU increases at a diminishingrate.

3. After consumption of the 5th chocolate, theconsumer does not derive any marginal utilityand the total utility also is the same as theprevious unit. This is the point of maximumsatisfaction or the point of satiety. When theTU is maximum, MU is zero.

4. On consumption of the 6th unit, the total utilityalso reduces from 24 to 22 and the marginalutility is negative i.e. -2 (disutility). Therefore,when total utility reduces, the marginal utilityis negative. This is the stage where consumerwould prefer not to consume the chocolate.

2

24

141210

864

16

20

26

18

22

-2-4

1 2 3 4 5 6

..

..

. ..

X

Y

. .

..

Point OfSatiety

Dis - Utility

NO. OF CHOCOLATES TU MU

1st 10 10

2nd 18 8 (18-10)

3rd 22 4 (22-18)

4th 24 2 (24-22)

5th 24 0 (24-24)

6th 22 -2 (22-24)

CONSUMPTION TU MU

2nd to 4th at diminishing rate

at 5th unit Max zero

at 6th unit Negative


LAW OF DIMINISHING MARGINAL UTILITY

1 VIDEO

2 HISTORY

3 SCHEDULE

4 DIAGRAM

5 ASSUMPTIONS

6 EXCEPTIONS

7 LIMITATIONS

8 IMPORTANCE


The Law of DMU explains economic behavior of a rational consumer.Mr. H. Gosses, a German Economist, was the first (in 1854) to explainthis law and hence it also called as Gossen’s First Law of Consumption.Prof. Alfred Marshall later on restated and propounded the law in hisbook ‘Principles of Economics’ in the year 1890.

2 FUNDAMENTAL PRINCIPLES:

– The more we have the less we want of it.

–Only a single want is satiable at a time.

H. GOSSESGerman Economist - 1854

In simple words, as the consumers acquires or consumes more andmore units of a commodity, the marginal utility derived from everysuccessive unit goes on declining.


“Other things being equal, the additionalbenefit which a person derives from theincrease in the stock of a thing diminisheswith every increase in the stock that healready has” – Alfred Marshall

SCHEDULE

The Law of DMU can be explained with the following utility schedule:

NO. OF CHOCOLATES

MU (MEASURED IN UTILS)

1st2nd3rd4th5th6th

1084 2 0 -2

1. When the consumerconsumes the first unit, themarginal utility (MU) is 10.

2. As consumption increases,MU keeps decreasing from10 to 8 to 4 to 2. Thisproves that as the stock ofthe commodity increases,the MU goes on declining.


SCHEDULE

The Law of DMU can be explained with the following utility schedule:

NO. OF CHOCOLATES

MU (MEASURED IN UTILS)

1st2nd3rd4th5th6th

108 4 2 0-2

3. Further, when the 5th unitof the commodity isconsumed, the MUbecomes zero. This is apoint of maximumsatisfaction or the pointof satiety.

4. When the consumerconsumes the 6th unit, theMU becomes negative i.e.-2. This indicates negativeutility or disutility.



The law of DMU can also be explained with the help of the followingdiagram:

Explanation to the diagram:1. In the diagram X axis

represents no. of unitsconsumed and Y axisrepresents marginal utility.

2. The MU curve is a downwardsloping curve from left toright. It indicates that increasein consumption of acommodity leads to decreasein the utility of thatcommodity.

10

8

6

4

2

-2

0

MA

RG

INA

L U

TILI

TY

NUMBER OF UNITS

Y

X

1 2 3 4 5 6

.

.

.

.

MU CURVE


The law of DMU can also be explained with the help of the followingdiagram:

Explanation to the diagram:3. The point at which the MU

curve intersects the X-axis iscalled the ‘point of maximumsatisfaction’ or the ‘point ofsatiety’. At this point, MU=0.

4. After further consumption,the MU curve slopesdownward below the X-axisindicating negative utility ordis-utility.

10

8

6

4

2

-2

0

MA

RG

INA

L U

TILI

TY

NUMBER OF UNITS

Y

X

1 2 3 4 5 6

.

.

.

.NEGATIVE UTILITY

MU CURVE

POINT OF MAXIMUM SATISFACTION

SMART CODE: ASSUMPTON

1.ALL OTHER FACTORS

CONSTANT

3.SUCCESSIVE CONSUMPTION

2.SIZE OF THE COMMODITY IS

REASONABLE

4.UNIFORMITY OF UNITS

6.PRODUCT OR COMMODITY IS

DIVISIBLE

5.MEASUREMENT

7.THE MU REMAINS

CONSTANT

9.NORMAL OR RATIONAL

BEHAVIOUR

8.ONLY SINGLE USE

LAW OF DMU - ASSUMPTIONS

The law begins with the words “otherthings being equal” i.e. the law assumesthat factors affecting utility of thecommodity to be constant. The law alsoassumes that MU of each unit of moneyremains constant for the consumer.E.g.: No change in price, income ofconsumer, habits, preferences, etc.

1.ALL OTHER FACTORS

CONSTANT


It is assumed that all the units of thecommodity consumed are neither verysmall nor very big. The size of thecommodity is reasonable i.e. of a standardsize.E.g.: A thirsty person will consume a glass ofwater and not a jar of water. Similarly, hewill not consume water in a teaspoon.

2.SIZE OF THE COMMODITY IS

REASONABLE


The Law of DMU assumed that there is notime gap between consumption of units i.e.there is continuity in consumption. The unitsshould be consumed back to back. If there isa time gap in consumption, the MU will notdiminish.E.g: After one unit of the commodity isconsumed, the consumer cannot consumethe next unit of the commodity after 2-3hours or the next day. The consumptionshould be back to back.


3.SUCCESSIVE CONSUMPTION

The Law of DMU assumed that all the unitsof the commodity being consumed areuniform. They are same or identical interms of shape, size, colour, smell etc.E.g.: If the commodity being consumed is aCadbury Dairy Milk, then all the other unitsconsumed also should be Cadbury DairyMilk only. The consumer cannot change toDairy Milk Silk.

4.UNIFORMITY OF UNITS


Utility is a psychological concept andtherefore it is not measurable cardinally.However, for explaining the Law of DMU,Prof. Alfred Marshall assumed that utilitycan be measured cardinally i.e. it can beexpressed in numbers.


5.MEASUREMENT

The Law of DMU assumed that thecommodity consumed by the consumer canbe divided into smaller parts so that it canbe acquired (purchased) in small quantitiesand consumed quickly.


6.PRODUCT OR COMMODITY IS

DIVISIBLE

It is assumed that the marginal utility ofmoney remains constant throughout theperiod of consumption for the consumer. Ifthe MU of money changes due to increaseor decrease in income, then it cannot yieldcorrect measurement of the MU of thecommodity. In short, the law will not holdgood.

7.THE MU REMAINS

CONSTANT


It is assumed that the commodity is used tosatisfy only a single want. If the commoditysatisfies many wants, the Law of DMUmight not apply as the marginal utility willkeep increasing. The consumer will keepusing the commodity to satisfy his variouswants.

8.ONLY SINGLE USE


In order for the Law of DMU to apply, it isassumed that the consumer is rational andbehaves normally. The aim of theconsumer should be to maximize hissatisfaction.

9.NORMAL OR RATIONAL

BEHAVIOUR


There are certain commodities for which the Law may not beapplicable. Such commodities may be different for differentpeople. You may feel that you can keep eating your favouritechocolates/ice-creams or you can watch ‘Dilwale Dulhaniya LeJayenge’ over and over again. These may be considered asexceptions to the law.Note: This paragraph is only for your understanding. Please do notwrite it in your exams.

EXCEPTIONS

EXCEPTIONS

1. MONEY 2. DRUNKARD

3. HOBBIES

6. MISER5. BOOKS

4. MUSIC

7. POWER

EXCEPTIONS

1. MONEYMoney is the biggest exception to the Law of DMU. MU ofmoney keeps increasing as stock of money increases asmoney can be used to satisfy various wants. However, moneycannot be considered to be real exception for the followingreasons:• Money does not have a single use and therefore it violates

one of the basic assumptions of the law.• Secondly, the MU of money for a rich person reduces as his

stock of money (bank balance) keeps increasing.

EXCEPTIONS

1. MONEYIt may be noted that the TU of money can never decreaseand hence MU of money cannot be zero or negative. Even therichest person will never have zero or negative utility ofmoney.E.g.: Mr. Mukesh Ambani will not tear or throw away a note ofRs. 10 because that note still has utility for him.

EXCEPTIONS

2. DRUNKARDThe MU of alcohol keeps increasing as a drunkard keepshaving more of it. The intoxication increases with every pegof alcohol. However, the drunkard cannot be considered to berational. The assumption of rationality is violated andtherefore, it cannot be considered to be a real exception tothe law.

EXCEPTIONS

3. HOBBIESA person having a hobby of collection of old coins, artifacts,painting, etc. gets more pleasure when he collects more of it.In other words, the MU keeps increasing. Hence it can be saidto be an exception to the law. However, the person does notcollect the same coins or artifacts and the assumption ofhomogeneity is violated. Hence, it is not a real exception.

EXCEPTIONS

4. MUSICThe law may also not be applicable to music as repeatedhearings of a song may give more satisfaction to the listener.However, it is not a real exception for the following reasons:• After a certain point, the law of DMU applies and the music

becomes monotonous.• The listener may listen to another song and then again listen

to the previous song.Thus, assumptions of homogeneity and continuousconsumption are violated.

EXCEPTIONS

5. BOOKSThe MU of a book keeps increasing fora scholar as his knowledge keepsincreasing when he reads the book.Therefore, it can be considered as anexception. However, the scholar mayacquire knowledge only on readingdifferent books and not reading thesame book again & again. Theassumption of homogeneity isviolated and hence it is not a realexception to the law.

EXCEPTIONS

6. MISERSA miser is a person who wants to accumulate more and morewealth and he does not want to even spend it. Therefore, theMU of money increases for a miser as the stock keepsincreasing. However, even here, the assumption of rationalityis violated and it cannot be considered to be a real exception.

EXCEPTIONS

7. POWERA person who has power / influence, keeps wanting more ofit. The MU of power keeps increasing as the person continuesto get more power. The greed for power does not end.Therefore it can be said to be an exception to the law. Again, itis not a real exception as the assumption of rationality isviolated.

SUMMARY

SR. NO EXCEPTION VIOLATES ASSUMPTION OF

1 Money Single use

2 Drunkard Rationality

3 Hobbies Homogeneity

4 Miser Rationality

5 Books Homogeneity

6 Music Homogeneity

7 Power Rationality

LIMITATIONS

Prof. Alfred Marshall explained to Law of DMU in his book‘Principles of Economics’. The Law of DMU states that “otherthings being equal, the additional benefit which a personderives from the increase in the stock of a thing diminisheswith every increase in the stock that he already has”

LIMIT

LIMITATIONS

The following are the limitation to the Law of DMU:(SMART CODE: LIMIT)

1.LAW OF DMU IS NOT APPLICABLE TO INDIVISIBLE

GOODS

2.IMPRACTICAL OR UNREALISTIC ASSUMPTION

3.MEASUREMENT OF UTILITY IS NOT POSSIBLE

CARDINALLY

4.ITS ASSUMPTION OF ‘SINGLE WANT’ NOT

PRACTICAL

5.THE MARGINAL UTILITY OF MONEY DOES NOT REMAIN

CONSTANT

1.LAW OF DMU IS NOT APPLICABLE TO INDIVISIBLE GOODS

Marginal utility can be calculated only when two or more unitsof a commodity are consumed successively at a time. Generally,a consumer will buy only one laptop or TV or house or mobileat a time. There will not be recurring purchase of such itemsand therefore it will not be possible to calculate the marginalutility on such goods.

LIMITATIONS

2.IMPRACTICAL OR UNREALISTIC ASSUMPTION

The Law of DMU is based on various assumptions likehomogeneity, rationality, constancy, successive consumption,etc. These assumptions are impractical and unrealistic.

IMPRACTICAL AND UNREALISTIC

LIMITATIONS

(in numeric terms)

LIMITATIONS3.MEASUREMENT OF UTILITY IS NOT POSSIBLE CARDINALLY

Utility is psychological concept and hence it cannot be measuredcardinally. However, the law assumes that utility can bemeasured cardinally. This assumption of the law is not practicallypossible. Utility can only be measured in relative terms.

LIMITATIONS4.IT’S ASSUMPTION OF SINGLE USE NOT POSSIBLE

A person may use one commodity to satisfy many wants at atime.E.g. Water may be used for cooking, cleaning, bathing, drinking

LIMITATIONS5.THE MARGINAL UTILITY OF MONEY DOES NOT REMAIN CONSTANT

The law assumes that the marginal utility of each unit of moneyremains constant. However, the MU of money changes:1. From one person to another2. For the same person from time to time.E.g.: The MU of money for a beggar will be more as compared toa wealthy person.

IMPORTANCE

IMPORTANCE1.TO THE FINANCE

MINISTER6.TO THE

PRODUCER

5.TO THE CONSUMER

4.TO THE MONPOLIST

3.TO UNDERSTAND ‘VALUE PARADOX’

2. TO THE GOVERNMENT

IMPORTANCE

1.TO THE FINANCE MINISTER

• The Law of DMU guides the finance ministerin framing the taxation policy wherein highertaxes are collected from the rich.

• This is because MU of money is less for themand there is a less burden of taxes on them.

• On the other hand, lower taxes are collectedfrom the poor as the MU of money is high forthem. This helps to reduce economicinequality in the country.

• MU of money is lower for rich means thatevery additional unit of money is not as dearto them as it would be for a poor person.

IMPORTANCE

2.TO THE GOVERNMENT

• The government provides welfare to the poorpeople through various welfare schemes.

• The law of DMU is useful to the governmentin implementing the economic policies likepublic distribution system, social justice etc.

• It helps to improve the welfare of the peoplein the society.

IMPORTANCE

3.TO THE ‘VALUE PARADOX’

• The Law of DMU explains ‘value paradox’ byshowing the difference between value in useand value in exchange. Some commoditieshave high value in use (i.e. they are veryuseful) while some commodities have highvalue in exchange (i.e. they can be exchangedfor a high price).

• Eg: A commodity like ‘air’ has high value inuse but no value in exchange. On the otherhand, ‘diamonds’ have high value in exchangebut no value in use.

• Greater value in use is determined by higherTU and greater value in exchange isdetermined by higher MU.

IMPORTANCE

4.TO THE MONOPOLIST

• A monopolist is at liberty to fix any price forhis product and even charge different price todifferent customers.

• Thus, he can charge higher price to richcustomers as MU of money is lower for them.

• On the other hand, he can charge a lowerprice to poor customers as MU of money ishigh for them.

IMPORTANCE

5.TO THE CONSUMER

• A consumer always tries to maximize hissatisfaction.

• Therefore, the consumer purchases thosecommodities wherein he feels that themarginal utility is equal to the price spentfor it.

• He, therefore, tries to maximize hissatisfaction.

• E.g.: You will hesitate to pay Rs. 50 for a vadapav because you know that the MU of theone vada pav is not worth Rs.50.

IMPORTANCE

6.TO THE PRODUCER

• The Law of DMU helps the producer to fixthe price of products.

• Larger the stock of the commodity, lower isthe MU and hence the producer may decideto fix a lower price for the product.

• On the other hand, smaller the stock of thecommodity, higher is the MU and hence theproducer may decide to fix a high price forthe product.

IMPORTANCE

6.TO THE PRODUCER

• E.g. The prices of “limited edition” items arekept very high because they producers havelimited stock of that item.

LAW OF EQUI-MARGINAL UTILITY

1 INTRODUCTION

2 SCHEDULE

3 CONCLUSION


When we come out of a cinema hall, we may comment “Picturevasool tha yaar” i.e. we were entertained worth the amountspent on movie tickets. We always try to derive maximumsatisfaction from the money that we spend. This is normalconsumer behavior and this has been explained in the Law ofEqui-Marginal Utility.

Note: The above paragraph isfor your understanding only.Please do not write it in anyexam.


The Law of Equi-Marginal Utility explains consumer equilibriumwhen he spends his income on various goods to maximizesatisfaction. According to Prof. Alfred Marshall, “Other thingsbeing equal, a consumer will distribute his money income ondifferent goods in such a way that the ratio of marginal utilitiesand their prices tends to be equal”.


In simple words, a consumer will derive maximum satisfaction when:

(MARGINALUTILITYDERIVED FROMCONSUMINGVARIOUSCOMMODITIES)

:(RESPECTIVEPRICES OFTHOSECOMMODITIES)

=THE MARGINALUTILITY OFMONEYINCOME OF THECONSUMER


E.g.: If there are three commodities, A, B and C, then theconsumer will derive maximum satisfaction when:

MUA = MUB = MUc = mPA PB Pc

Where, MU = Marginal UtilityP = Pricem = Marginal utility of given money income.


The law of equi-marginal utility can be explained with the help offollowing schedule:

Units of

CommodityMU of A

Ratio=

MUA

PA

MU of B

Ratio=

MUB

PB

MU of C

Ratio=

MUC

PC

1st 24 24/2=12 30 30/3 = 10 32 32/4 = 8

2nd 20 20/2 = 10 24 24/3= 8 24 24/4 = 6

3rd 16 16/2= 8 18 18/3 = 6 16 16/4= 4

4th 12 12/2 = 6 12 12/3= 4 8 8/4 = 2

5th 8 8/2= 4 6 6/3 = 2 0 0/4 = 0

Where, Price of A =2, Price of B = 3, Price of C = 4


Suppose, the consumer’s income is Rs. 25, he would spend theamount in order to get maximum satisfaction. As per the law, theconsumer would get maximum total satisfaction when:MUA = MUB = MUc = mPA PB Pc


In the schedule there are three points of equi-marginal utility (i.e. 8, 6 & 4)

1. When the ratio is equal to 8, it means that the consumer will buy 3 units of A, 2 units of B and I unit of C. in this case, the total expenditure will be:A = 3 x 2 = 6B = 2 x 3 = 6C = 1 x 4 = 4

16 (i.e. < 25)



2. When the ratio is equal to 4, it means that the consumer will buy 5 units of A, 4 units of B and 3 units of C. In this case, the total expenditure will be :A = 5 x 2 = 10B = 4 x 3 = 12C = 3 x 4 = 12

34 (i.e. > 25)



3. When the ratio is equal to 6, it means that the consumer will buy 4 units of A, 3 units of B and 2 units of C. In this case, the total expenditure will be :A = 4 x 2 = 8B = 3 x 3 = 9C = 2 x 4 = 8

25 (=consumer’s income)


Therefore, the consumer will get maximum satisfaction when :MUA = MUB = MUc = mPA PB Pc

i.e. 12 = 18 = 24 = 62 3 4


The following table shows the consumer’s allocation towardsvarious commodities and the total utility derived from the givenincome:

Commodity No. of Units Total Spend Total Utility

A 4 8

( 4 x 2)

72

(24+20+16+12)

B 3 9

(3 x 3)

72

(30 + 24 +18)

C 2 8

(2 x 4)

56

(32 + 24)

25 200


Conclusion:Thus, it can be observed that the Law of Equi-Marginal Utilityguides the consumer to get maximum satisfaction from the givenincome, while arranging his total expenditure.

chapter 2 consumer behaviour (utility analysis) 2 - consumer behaviour.pdf · chapter 2 consumer...

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