utility analysis1

8/14/2019 Utility Analysis1

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Utility is the power or capacity of a

commodity to satisfy human wants.As long as a commodity has some use i.e. ,it has the capacity to satisfy a person ithas the UTILIY.


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1. Utility is subjective(deals with mental

satisfaction)2. Utility is Relative(does not remain

constant)

3. Not essentially useful.


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1. Total Utility- TU refers to the entireamount of satisfaction obtained from

consuming various quantities of acommodity.

TUx = F(Qs)


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2. Marginal Utility MU is the increase in TUwhich results from a unit increase inconsumption.

MU = TU-----

Q


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5

Q ($) TU ($) MU

0 0

1 40 40

2 85 45

3 120 35

4 140 20

5 150 10

6 157 7

7 160 3

8 160 09 155 -5

10 145 -10

145


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6

Total Utility

0

50

100

150

200

1 2 3 4 5 6 7 8 9 10 11

($) MU

-20

-10

0

10

20

30

40

50

1 2 3 4 5 6 7 8 9 1 11

Q ($) TU ($) MU

0 0

1 40 40

2 85 453 120 35

4 140 20

5 150 10

6 157 7

7 160 3

8 160 0

9 155 -5

10 145 -10

145


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IC analysis refers to the locus of pointsrepresenting the various combinations oftwo goods which yields the same level ofsatisfaction to the consumer.


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1 Rationality- (maximum satisfaction)

2Ordinal Utility-(consumer can rank his

preferences)

3Diminishing marginal rate ofsubstitution(the rate at which certain

amount of one commodity is substituted foranother is called MRS)


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4. Axioms of comparison-Any 2combinations of X & Y commodities can becompared in preference by an individual-

A) A is preferred to B.B) B is preferred to A.

C) A&B are indifferent


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5.Consistency

6. Transitivity- Assumes there are three

combinations of goods A,B,C. If A ispreferred to B and B is preferred to C ,thenA must be preferred to C .

7. Scale of preference independent ofmarket price.


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COMBINATION GOOD X GOOD Y

A 2 18

B 4 13

C 6 9

D 8 6


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Higher indifference curves represent larger

quantities of goods than lowerindifference curves.


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A consumer is willing to give up one good

only if he or she gets more of the other

good in order to remain equally happy.

If the quantity of one good is reduced, thequantity of the other good must increase.

For this reason, most indifference curves

slope downward.


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QY

QX

QY

QX

PerfectComplements

PerfectSubstitutes


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PRICE LINE OR BUDGET LINE-

It shows all the different combinations of thetwo commodities that a consumer canpurchase ,given his money income and theprice of the two commodities.


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It is a straight line. It has a negative slope. Its slope indicates ratio of prices of two

goods.


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20


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Combination of goods that maximizes utilityfor a given set of prices and a given level ofincome

Represented graphically by the point oftangency between an indifference curveand the budget line

MUX/MUY = PX/PY

MUX/PX = MUY/PY


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utility analysis1

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