ASSIGNMEMT

Subject:
Micro Economics
Submitted to:
Ms. Aneela Akhtar Chattha
Submitted by:
Abdul Haris
Registration No:
21-UOC/BBA-42
Date:
Wednesday, 2 February 2022
Department:
BBA
 Utility Definition:
It is a measure of satisfaction an individual gets from the consumption of the commodities.

Cardinal Utility:

Definition: The Cardinal Utility approach is propounded by neo-classical economists,

who believe that utility is measurable, and the customer can express his satisfaction in
cardinal or quantitative numbers, such as 1,2,3, and so on.

The neo-classical economist developed the theory of consumption based on the

assumption that utility is measurable and can be expressed cardinally. And to do so,
they have introduced a hypothetical unit called as “Utils” meaning the units of utility.
Here, one Util is equivalent to one rupee and the utility of money remains
constant.

Limitation of Cardinal Approach

 In the real world, one cannot always measure utility.

 One cannot add different types of satisfaction from different goods.

 For measuring it, it is assumed that utility of consumption of one good is

independent of that of another.

 It does not analyze the effect of a change in the price.

Over the passage of time, it was realized that the absolute measure of utility is not
possible, i.e. it was difficult to measure the feeling of satisfaction cardinally (in
numbers). Also, it was difficult to quantify the factors that cause a change in the moods
of the consumer, their tastes and preferences and their likes and dislikes. Therefore, the
utility is not measurable in quantitative terms. But however, it is being used as the
starting point in the consumer behavior analysis.The consumption theory is based on
the notion that consumer aims at maximizing his utility, and thus, all his actions and
doings are directed towards the utility maximization. The consumption theory seeks to
find out the answers to the following questions:

 How does a consumer decide on the optimum quantity of a commodity that he/she
wishes to consume?
 How consumers allocate their disposable incomes between several commodities of
consumption, such that utility is maximized?
The cardinal utility approach used in analyzing the consumer behavior depends on the
following assumptions to find answers to the above-stated questions:
1. Rationality: It is assumed that the consumers are rational, and they satisfy their wants
in the order of their preference. This means they will purchase those commodities first
which yields the highest utility and then the second highest and so on.
2. Limited Resources (Money): The consumer has limited money to spend on the
purchase of goods and services and thus this makes the consumer buy those
commodities first which is a necessity.
3. Maximize Satisfaction: Every consumer aims at maximizing his/her satisfaction for the
amount of money he/she spends on the goods and services.
4. Utility is cardinally Measurable: It is assumed that the utility is measurable, and the
utility derived from one unit of the commodity is equal to the amount of money, which a
consumer is ready to pay for it, i.e. 1 Util = 1 unit of money.
5. Diminishing Marginal Utility: This means, with the increased consumption of a
commodity, the utility derived from each successive unit goes on diminishing. This law
holds true for the theory of consumer behavior.
6. Marginal Utility of Money is Constant: It is assumed that the marginal utility of money
remains constant irrespective of the level of a consumer’s income.
7. Utility is Additive: The cardinalists believe that not only the utility is measurable but
also the utility derived from the consumption of different commodities are added up to
realize the total utility.
Thus, the cardinal utility approach is used as a basis for explaining the consumer
behavior where every individual aims at maximizing his/her utility or satisfaction for the
amount of money he spends on the consumption of goods and services.

Law of Diminishing Marginal Utility:

Definition: The law of Diminishing Marginal Utility posits that with the more and

more consumption of the units of the commodity the utility derived from each successive
unit goes on diminishing, provided the consumption of other commodities remain
constant.

The concept of the law of diminishing marginal utility can be understood through a real
life example. Suppose you are thirsty, and as you drink the first glass of water, keeping
the consumption of all other commodities constant, you get the maximum satisfaction,
and with each successive glass of water, the additional benefit (utility) diminishes.

Assumptions

The law of diminishing marginal utility is based on the following assumptions.

• The consumer should be rational

• There is the cardinal measurement of utility

• Units of a product are homogeneous

• Constant marginal utility of money

• No time gap in consumption

Taste, habit, and performances of a consumer remain the same

• Units in consumption are suitable in size

• The mental and social condition of the consumer must be normal.

The law of diminishing marginal utility can be illustrated through the table given below.
Suppose there is a commodity X, whose utility can be measured in the quantitative
terms. Also, the total utility and marginal utility of the commodity is given in the table.

Units of Commodity X Total Utility (Tux) Marginal Utility (MUx)

1 30 30

2 50 20

3 65 15

4 70 5

5 65 -5

6 45 -20
 Units of Commodity X Total Utility (Tux) Marginal Utility (MUx)

As shown in the table., with the increase in the consumption of the units of commodity
X, the total utility increases, but at a diminishing rate. The marginal utility also
diminishes with the consumption of each successive unit of X.

As shown in the fig. TUx increases as a result of the consumption of additional units of

the commodity X while the MUx is a downward sloping curve, which shows that the
utility diminishes with the consumption of more and more units of the commodity X. At
units 4, the TUx reaches to the maximum point, the Point of Saturation denoted as M,
from where the TUx starts declining. Beyond this point, i.e. as the TUx starts declining
the MUx becomes negative. The downward sloping Marginal utility curve illustrates the
law of diminishing marginal utility.

Relationship between Total Utility and Marginal Utility:

There is a direct relationship between total utility and marginal utility. Total utility is
always based on marginal utility as a total utility (TU) is the summation of marginal
utilities. The relationship between TU and MU can be explained with help of the
following table.
 Units of Goods Total Utility Marginal Utility Description
consumed (TU) in Utils (MU) in utils

1 10 10 TU is increasing
and MU is positive

2 18 18−10=8

3 24 24−18=6

4 28 28-24=4

5 30 30−28=2

6 30 30−30=0 MU is Zero, TU is
maximum

7 28 28−30=−2 MU is negative,
TU starts
declining

TU and MU, their relationship

In the above table, there are three forms of marginal utility (MU) as positive, zero ,and
negative marginal utility. Up to 5 units of consumption, marginal utility (MU) is
decreasing and remains positive. Until the marginal utility (MU) is positive, total utility
(TU) surges/rises at a declining rate .When a consumer consumes the 6th unit of the
commodity, s/he gets no utility or there is zero utility and as a result, total utility (TU)
remains constant and becomes maximum. After the 6th unit, if the consumer keeps
consuming or if s/he consumes the 7thunit of the commodity, marginal utility (MU)
becomes negative and with negative marginal utility (MU), total utility (TU) starts to
decline .It can be graphically explained as below.
In the diagram, TU is the total utility curve and MU is the marginal utility curve. As
the consumer consumes the first unit of commodity, s/he obtains 10 utils of utility.
Here both TU and MU are the same .When the consumer consumes 2nd unit of goods,
TU increases to 18 utils from 10utils and MU decreases to 8 utils. By adding MUS TU is
obtained. Accordingly, when the consumer consumes the 6th unit of goods, MU
decreases to zero where TU becomes maximum (30 utils). After the 6th unit
consumption of goods, MU is negative (-2) and due to negative MU, total utility declines
to 28 utils from 30 utils. Thus, the consumer gets maximum satisfaction when MU is
zero and that point is known as the point of saturation. Therefore, total Utility, marginal
Utility, and their relationship can be summarized as below.

• The TU curve begins from the origin, increases at a decreasing rate, reaches a
Maximum , and then starts falling.
• MU curve is the slope of the TU curve and given by MU=ATU/AQ
 • When TU is maximum, MU is zero. It is referred to as the saturation point. It
indicates that units of the good are consumed till the saturation point.
• Until the TU curve is concave, the MU curve is downward sloping and remains
above the x-axis.
• Once When TU curve is falling, the MU curve becomes negative.
• The falling part of the MU curve demonstrates the law of diminishing
marginal utility.

Conclusion:
The relationship between the Total Utility and Marginal Utility can be summarized
as:

 When MU decreases, TU increases at a decreasing rate.

 When MU is Zero, TU is maximum.
 When MU is negative, TU starts declining.

Thus, the law of diminishing marginal utility holds universally, for both the durable and
non-durable goods. In certain conditions, such as accumulation of money, a hobby of
collecting old coins, stamps, visiting cards, etc. the marginal utility might initially
increase, but eventually, it starts declining.