Cardinal utility


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Cardinal utility

  2. 2. UTILITY The satisfaction which a consumer gets by having or consuming goods or service is called utility. Varies from: unit to unit, time to time, and place to place for same consumer Same commodity gives different utility to different consumers
  3. 3. Measurement of Utility Cardinal is a Latin word, which comes from utils (number). Utility can be measured in units called- cardinal utility. Utils are not well defined, but helps to know consumer behavior.. Useful to distinguish between two concepts: (1)total utility (2)marginal utility
  4. 4. Total Utility Sum total of satisfaction By consuming various units of commodity More units- greater satisfaction Saturation point- maximum total utility Further consumption TU starts declining
  5. 5. Marginal Utility Change in the total utility resulting from 1 unit change in the consumption of good. MUx= TUx Qx
  6. 6. Basic assumptions Utility can be measured so,comparision can be possible. Utility is independent. Constant marginal utility.  Example..utility of money is constant Introspection:  it is assumed that a mind of a person works in a similar situation.
  7. 7.  “For any individual Consumer the value that he attaches to successive units of a particular commodity will diminish steadily as his total consumption of that commodity increase, the consumption of all other goods being held constant”. (R.G.Lipsey)  The additional benefit which a person derives from a given increase in his stock of a thing diminishing with every increase in stock that already he has.
  8. 8. Diagram
  9. 9. ASSUMPTIONS OF THE LAW OF DIMINISHING MARGINAL UTILITY • Various units of the good are homogeneous. • There is no time gap between consumption of the different units. • Consumer is rational • Tastes, preference, and fashions remain unchanged
  11. 11. CASE FACTS Economist calculated the following“mean happiness rating” Very happy= 4 Prettey happy= 2 Not too happy= 0 In advance nations economist found that higher incomes were positively correlated with happiness responses which leads to satisfaction.
  12. 12. Following two situation given when people become happy: Happiness is based on relative rather than absolute income. Happiness quickly adapts to changes in the level of income.
  13. 13. Happiness is also based on society means as individuals become richer, they become happier but when society as a whole grows richer, nobody seems happier. This type of situation seems in advance societies like U.S, U.K, France etc. But in poor countries, higher incomes do make people happier.
  14. 14. Consumer equilibrium
  15. 15. Consumer equilibrium
  16. 16. Cardinal approach
  17. 17. Recap
  18. 18. Law of diminishing marginal utility
  19. 19. Recap
  20. 20. Adverse Selection • Averse selection is a process in which undesired result occur when buyers and sellers have different set of information. • To counter the effects of adverse selection, insurers (to the extent that laws permit) ask a range of questions to individuals who apply to buy insurance so that the price quoted can be varied accordingly, and any unreasonably high or unpredictable risks rejected.
  21. 21. Question : What details does an insurance company require to know before it will insure a person to drive a car? i. Personal Details i.e. age, height ,weight ,full description of occupation and average monthly income. ii. Physical condition.[any disability or not] iii. Habits.[like drink and drive, smoking while driving] iv. Other or Previous insurance. v. Previous accidents. vi. License[full detail of it] vii. Sum insured. viii.Declaration
  22. 22. MORAL HAZARD  Insurance makes less careful to company and increases risk to the insurance company.
  23. 23. Case facts Insurance against theft of bicycle. Insurance increases risk to the insurance company. Risk analysis.
  24. 24. How to reduce moral hazard?
  25. 25. Following are used to reduce moral hazard... A no claims bonus. The company only being prepared to insure an item for part of its value. Offering lower premiums to those less likely to claim.
  26. 26. Conclusion...
  27. 27. Case Study on “BISCUIT DID THE TRICK”
  28. 28. Conclusion: This case is relate to the concept of equilibrium of the consumer. In equilibrium, the consumer balances the utility of good against its cost. MU = P Therefore, She bought a cup of coffee with a pair of biscuits at 10 Rs.
  29. 29. Law of equi marginal utility “A consumer maximize his total utility by allocating his income among goods and services in such a way that the marginal utility derive from the last rupee spent on one goods equals to the other goods”
  30. 30. Marginal utility schedule Units of money MU of X MU of Y 1 20 24 2 18 21 3 16 18 4 14 15 5 12 9 6 10 3
  32. 32. 1. All goods under consideration and their individual units need to be homogeneous, both qualitatively as well as quantitatively. 2. Tastes, habits, fashions and income of the consumer remain unchanged. 3. Consumption need to be a continuous process. 4. Marginal utility of money is assumed to be constant.
  33. 33. Taking account of time Can I spare time to enjoy myself?
  34. 34. conclusion • Opportunity cost of doing an activity is the sacrifice of time. • Now a days, utility of time is higher than the utility of money. • You have to consider relative marginal utility of activity against relative marginal cost.