CARDINAL UTILITY ALALYSIS

Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility states that as more and more

units of a commodity is consumed, marginal utility derived from every
additional unit must decline.

Two Basic Assumptions:

• Only standard units of a commodity are consumed. E.g. a cup of tea,
not a spoon of tea.
• Consumption of the commodity must be continuous.
• The wants are satiable
Utility Table
Quantity(units) Total Utility Marginal Utility

0 0 -

1 8 8- 0 =8

2 14 14- 8 =6

3 18 18 -14 =4

4 20 20 -18 =2

5 20 20 -20 =0

6 18 18 – 20 =-2
Observations:
• As more and more units of commodity are consumed, marginal utility
derived from each successive unit tend to decline.
• So long as MU is positive, TU increases.
• TU is maximum when MU is zero.
• TU starts decreasing when MU is negative.
• Decreasing MU implies that TU increases at a decreasing rate.
 Diagrammatic Representation
Total and Marginal Utility curves
Total Utility 0 Marginal Utility -
25

20

15
TU& MU

10

0
1 2 3 4 5 6

-5
Quantity
Consumer’s Equilibrium
Consumer is in equilibrium when, given his income and market price, he
plans his expenditure in such a manner that he derives his total
satisfaction.

Ques. How much of a commodity a consumer buys so that he maximises

his satisfaction and attains the point of equilibrium?
Two different situations:
1. When only one commodity is consumed
2. When two or more commodities are consumed
Consumer’s Equilibrium: one commodity case

Factors Affecting Purchase :

• Price of the commodity
• Marginal utility of the commodity
• Marginal utility of money
What is Marginal Utility of Money ?

It refers to worth of a rupee to a consumer. The consumer defines it in

terms of the utility he derives from a standard basket of goods he can
buy with a rupee.
Example: if a rupee can buy 100g of sugar, 500g of rice and 500g of salt
and if total utility from these is 4 utils, then 4 is to be taken as marginal
utility of money.
• MUm becomes a measuring rod for a rupee worth satisfaction.
• It is constant.
Example: Let X be the commodity he intends to buy.
MUm= 4 utils( spending Re 1 he expects 4 utils of satisfaction
Let Px =Rs 4 per unit
Marginal Utility schedule

Units of a commodity X MUx (utils)

1 20
2 18
3 16
4 10
5 0
6 -5
Conversion of MUx into Rupees

Units of commodity X MUx (utils) MUx/Px ( actual utility

derived per Rupee)
1 20 20/4 = 5

2 18 18/4 = 4.5

3 16 16/4 = 4

4 10 10/4 = 2.5

5 0 0/4 = 0

6 -5 -5/4 = -1.25
Consumer’s Equilibrium: Two or more commodity
case
• Two commodities X and Y
• Income is given
• Price is given
• In case of one commodity X equilibrium condition strikes when
MUx/Px =MUm Eq 1
Likewise for commodity Y,
MUy/Px =Mum Eq 2
Relating both the eq.
• MUx/Px= MUy/Py=MUm -----Equilibrium condition
Income=Rs88
Price of X&Y=Rs8

Units of Price(Rs) MUx MUy MUmx(Mux/Px) MUmy(Muy/Py)

commodity
1 8 88 40 11 5

2 8 72 36 9 4.8

3 8 64 24 8 3

4 8 56 20 7 2.8

5 8 48 16 6 2

6 8 40 12 5 1.8

7 8 32 8 4 1

8 8 24 4 3 0.8

9 8 16 0 2 0