UTILITY ANALYSIS

 Utility is the Power of a Commodity to satisfy human

wants.

 There are two different Approaches to Utility

Analysis

1. Cardinal approach to utility analysis

2. Ordinal approach to utility analysis
CARDINAL APPROACH
 This School believes that Utility is Measurable and is
a Quantifiable entity.

 Cardinal Approach gives exact measurement by

assigning definite numbers such as 1, 2, 3, etc.

Assumptions of the Cardinal Marginal Utility

1. Cardinal Measurement of Utility
2. Marginal Utility of Money
3. Introspection Utilities are Independent
4. Constant
TOTAL AND MARGINAL UTILITY
 Total Utility is the sum total of the units of utility which
an individual derives from the consumption of a
commodity during a specified period of time.

 Marginal Utility is the change in the total utility

resulting from a one-unit change in the consumption of
a commodity per unit of time.

 Marginal Utility is the addition made to the total utility

by the consumption of the last unit considered just
worthwhile.
MU = Change in Total Utility
Change in Quantity Consumed
Total & Marginal Utility Relationship
 Total Utility starts increasing by decreasing ratio while
Marginal Utility starts decreasing.

 When Total Utility is at its maximum point and

thereafter starts decreasing, Marginal Utility comes to
zero.

 After the maximum point has been achieved by total

utility it starts decreasing which causes marginal utility
to become negative.
LAW OF DIMINISHING MARGINAL UTILITY

 The German Economist H. Gossen who was first to

explain the law said that “As the consumer consumes
more and more units of a commodity, the utility from
the successive units goes on diminishing”.
 Marshall explains the law as “The additional benefit,
which a person derives from an increase of his stock of
a thing, diminishes with every increase in the stock that
he already has”.
TOTAL & MARGINAL UTILITY

Units Total utility Marginal utility

1 10 10
2 15 5 (15-10)
3 19 4 (19-15)
4 22 3 (22-19)
5 23 1 (23-22)
6 23 0 (23-23)
7 21 -2 (21-23)
DIMINISHING MARGINAL UTILITY
FIGURE
Y

Marginal Utility
Analysis

MU

Units X
LIMITATIONS OF THE LAW
 Suitable Units
 Suitable Time
 No Change in Consumer’s Taste
 Rationality
 Rare Collections
 Change in Our & Other Peoples’ Stock
 Fashion
 Not Applicable to Money
APPLICATIONS OF LAW OF
DIMINISHING MARGINAL UTILITY

 Helps in Taxation
 Price Determination
 Household Expenditure
 Basis of law of Demand
 Socialists View
 Consumer’s Surplus Concept
LAW OF EQUI-MARGINAL UTILITY
 It is an extension of the law of Diminishing Marginal
Utility to two or more commodities.

 Given the income of a consumer, the law states that

consumer can get maximum satisfaction when the
Marginal Utility of the last rupee spent on each
commodity yield the same utility.

 To get maximum satisfaction, consumer will substitute

one good for another.

 It is also called as Law of Substitution, Law of

Indifference, or Law of Maximum Satisfaction.
LAW OF EQUI-MARGINAL UTILITY
 Under Law of Equi-marginal utility consumer
equilibrium can be stated in the following formula.

MUx = MUy = …… MUn

Px Py Pn
EXAMPLE
 Suppose consumer is buying two Goods X and Y and marginal utility of them
are given as
Units of X & Y MU x MU y
1 33 36
2 30 32
3 27 28
4 24 24
5 21 20
6 18 16

 Suppose the prices of good X & Y are Rs. 3 & Rs.4 respectively and total
income is Rs.20. The above table can be reconstructed by dividing the
marginal utilities of good X by Rs. 3 and marginal utilities of good y by Rs. 4.
The Resulting Marginal Utility Table

Units of Money MU x MU y
Px Py
1 11 9
2 10 8
3 9 7
4 8 6
5 7 5
6 6 4
LIMITATIONS OF THE LAW
 Rationality
 Effects of Fashion and Customs
 Ignorance
 Indivisible Units
 Questionable Assumptions
PRACTICAL IMPORTANCE OF THE LAW

 Applications to Consumption
 Applications to Production
 Applications to Exchange
 Price Determination
 Applications to Distribution