AEC 135

Agricultural Economics

Utility Analysis
A prudent and sensible consumer spends his limited income on various goods and services
very carefully and in a way that he gets the best level of satisfaction. Consumer’s
optimization behavior is that behavior which relates to the purchase of those goods and
services which provide him maximum satisfaction from his limited income. However in order
to explain consumer’s behavior, it is essential to discuss cardinal utility analysis.

Concept of Utility
Stanley, Jevons, a noted classical Economist, originated the concept of utility as the
fundamental basis of consumers demand for a commodity. Utility refers to the wants
satisfying power or capacity of a commodity or services assumed by the consumer. In a
word, utility denotes satisfaction. Utility express potentiality of satisfaction in a commodity.
Utility is an introspective or subjective or relative term. It relates to the consumers mental
attitude and experience regarding a given commodity or service. Thus utility of a commodity
may differ from person to person, as psychologically, every individual has an own
experiences.
Utility means the capacity of a commodity or services to satisfy the human needs.

Utility Function
A function which states that an individual’s utility has been dependent upon the goods he
consumes and their amounts. More formally, written as
U= u (X, Y, Z)
Where, X, Y, Z are the amounts of the goods.

In respect of consumption there are two types of utility.

1. Total utility
2. Marginal utility

Total Utility
The concept of total utility and marginal utility are the basic concepts in the cardinal
measurement of utility.

The total utility means the total satisfaction gained by the consumer regarding all units of
commodity taken together in consumption or acquired at a time.

In this schedule, we have assumed a cardinal measurement of utility in terms of so many

units expressed in numbers, it can be seen that when our consumer buys 5 units of X, he
derives 10 units of satisfaction. Total utility measures the strength of the consumer’s demand
for the entire stock of the given commodity.
We can illustrate total utility numerically in table 1.

Units of commodity X Total utility of X Marginal Utility

0 0 -
1 4 4
2 7 3
3 9 2
4 10 1
5 10 0
6 9 -1
7 7 -2

The satisfaction that a person gets from consuming total number of units.
Mathematically, TU= u(X) + u(Y) + u (Z)

Marginal Utility

Marginal utility can be defined as the change in the total utility resulting from a one unit
change in the consumption of a commodity per unit of time.
Marginal utility means the extra utility added by the last unit of a good consumed by a
consumer. A good may be having a very low marginal utility but a very high total utility, e.g.
water. Supposing, if four units of bread gives 10+9+7+4= 30 units of utility, while the three
units had given 10+9+7= 26 units, the addition made by the fourth unit is 30-26= 4. The
marginal unit is, therefore, the fourth unit and the marginal utility is 4.
Marginal utility can be measured with the help of the following formula:

MUn= TUn – TUn-1 , Or,

MU= ∆TU/∆Q

Here, MUn= Marginal utility of the nth unit.

TUn= Total utility of ‘n’ units.

TUn-1= Total utility of ‘n-1’ units.

Or: ∆TU= Change in Total Utility.

∆Q= Change in the quantity of ‘x’ commodity.

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Relationship between Total Utility and Marginal Utility

Figure 1 shows graphically the relationship between total utility and marginal utility from the
table 2. The marginal utility become zero and negative, when the marginal utility is zero then
total utility is maximum.

Table 2. Relationship between total utility and marginal utility

Units of commodity Total utility of n Marginal utility

0 0 0
1 4 4
2 7 Increasing 3 Positive
3 9 2
4 10 1

5 10 Maximum 0 Zero

6 9 Decreasing -1 Negative
7 7 -2

In fig 1. The curve MU represent marginal utility and the curve TU total utility, it is easy to
see that as the MU curve slopes downwards, TU curve slopes upwards. Indicating that total
utility increases at the rate of increasing rate but marginal utility is diminishing though
positive. When the MU curve intersect the x-axis to the extent, the TU curve is as its peak,
meaning that when marginal utility is zero, total utility is maximum. When the MU curve
enters the negative quadrants, the TU curve starts moving downward, indicating that total
utility decrease when the marginal utility is negative.

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 Fig. 1: Relationship between total utility and marginal utility

We derive the following conclusions from the relation between total utility and marginal
utility:

i. When marginal utility is positive total utility increases.

ii. When marginal utility is zero total utility is maximum.

iii. When marginal utility is negative total utility diminishes.

Laws of Utility Analysis

There are two main laws of utility analysis:
1. Law of Diminishing Marginal Utility
2. Law of Equi- Marginal Utility

1. Law of Diminishing Marginal Utility

Law of diminishing marginal utility is the fundamental law of utility analysis. All of us
experience this law in our daily life. The law of diminishing marginal utility explains the
relation between utility and quantity of a commodity. It is a psychological fact that when a
consumer gets more and more units of a commodity, during a particular time, the utility from
the successive units will diminish.

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Basic Assumptions of Marshallian Utility Analysis
The law of diminishing marginal utility holds true under certain assumptions. These
assumptions are usually expressed by a single phrase, “other things being equal” in the
statement of the law.

The following are the important assumptions.

1. Utility can be measured in cardinal numbers.
2. Marginal utility of money remains constant.
3. Marginal utility of every commodity is independent.
4. Every unit of the commodity being used is of same quality and size.
5. There is continuous consumption of the commodity.
6. Suitable and proper quantity of the commodity is consumed.
7. There is no change in the income of the consumer.

Statement of the law

Marshall states the law thus, “The additional benefit which a person derives from a given
increase of his stock of a thing diminishes with every increase in stock that he already
has”.

Table: Total and marginal utility

Units (glass of water) Total utility Marginal utility
1 20 20
2 38 18
3 53 15
4 64 11
5 70 6
6 70 0
7 62 -8
8 46 -16

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The diagram illustrates the law of diminishing marginal utility as applied to the consumption
of glass of water. OX and OY are the two axes. Units of commodity (glass of water) are
measured along OX and units of utility along OY axis. On taking the 1st glass of water, the
consumer gets 20 units of utility, because he is very thirsty. When he takes 2nd glass of
water, his marginal utility goes down to 18 units because his thirst has been partly satisfied.
This process continues until the marginal utility drops down to zero which is the saturation
point. By taking the seventh glass of water, the marginal utility becomes negative because the
thirst of the consumer has already been fully satisfied.

Limitations of the law

1. Suitable units.
2. Suitable time.
3. No change in consumers tastes.
4. Measurement of utility is not possible.
5. Marginal utility of money does not remain constant.
6. Utility is relatively not independent.
7. Normal persons.
8. Constant income.
9. Rare collection.
10. Change in other peoples stock.
11. Other possessions.
12. Fashion.

Law of Equimarginal Utility

The law of equimarginal utility states that “The consumer will distribute his money
income between the goods in such a way that the utility derived from the last taka spend
on each good is equal.”
In other hand “Consumer is in equilibrium position when marginal utility of money
expenditure on its good is the same”.
MUE = MUX /PX = MUY /PY

Applications of the Law

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The Law of the Equi- Marginal Utility, has a very wide application. It is applicable to the
utilization of time, distribution of assets in various forms and the allocation of resources
among various uses. It also applies to the use of money now and its use in the future, i.e., in
spending in the present and saving in the future. The law is applicable to all branches of
economic theory.

1. It applies to the consumption

2. Its application to production
3. Its application to exchange
4. Price determination
5. Its application to distribution
6. Public finance
Thus the law applies in all branches of economic theory. It has also got great practical
importance.

Equilibrium Situation

It has been stated that a consumer derives maximum satisfaction when the marginal utilities
of money spent on two commodities are equal. Here we assume rational behavior on the part
of the consumer so that it is maximum satisfaction that he seeks and we suppose he is capable
of making careful comparisons and calculations.

Table: Marginal Utility of Goods X and Y

Units MUX MUY
1 33 36
2 30 32
3 27 28
4 24 24
5 21 20
6 18 16
Suppose the price of good X is Tk. 3/ unit and price of good Y is Tk. 4. The above table can
be reconstructed by dividing the marginal utilities of X by Tk. 3 and the marginal utilities of
Y by Tk. 4.
Table: Marginal utility of money expenditure

Units MUX/PX MUY/PY

1 11 9
2 10 8*
3 9 7
4 8* 6
5 7 5
6 6 4

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If the income of the consumer is Tk.20, he will spend Tk.12 on X goods and 8 on Y goods. In
this situation, total expenditure: 4* Tk. 3+ 2* Tk. 4= Tk. 20. He will buy 4 units of good X
and 2 units of good Y, where the marginal utility of money expenditure is equal i.e. 8 units.

We can show it in graph:

MUX/PX
A MUY/PY
MUm

Quantity
F G

Fig: Consumers equilibrium

In equilibrium situation a consumer will consume OG of X goods and OF of goods Y.