Theory of utitltiy

1. Theories of Utility
•Utility is the want satisfying power of a commodity
•Is the psychological feeling of satisfaction, pleasure, happiness or well
being which a consumer derives from the consumption, possession or the
use of a commodity.
•In economics, it is ethically neutral.
•Utility is subjective or relative. Eg: Alcohol
•Varies from person to person.
•A commodity need not have the same utility for the same consumer at
different points of time.
Total Utility
•It is the sum total of the satisfaction which a consumer receives by
consuming various units of the same commodity.

2. Marginal Utility
•It is the additional utility derived from additional unit of a commodity
consumed.
The law of Diminishing Marginal Utility
•Based on an important fact that while total wants are unlimited, each single
want is satiable.
•Alfred Marshall, the exponent of the above theory defines the law as “ The
additional benefit which a person derives form a given increase of his stock
of a thing, diminishes with every increase in the stock that he already has”
•Mean that as the consumer consume more of a commodity, the utility of
every additional unit consumed diminishes.

5. Relationship between Total Utility and Marginal Utility
• When TU rises the MU diminishes.
• When the TU is maximum then the MU is zero
• When the TU is diminishing then the MU is negative.
Reasons for this phenomena
•Even though, human wants are unlimited, yet a particular want can be
fully satisfied. His marginal utility decreases as consumption of that
commodity increases and it reaches zero and even negative.
•Goods are imperfect Substitutes to one another.
Limitation
•1. Homogeneity – size and quality must be same.
•2. Suitable time.
•3. No change in the taste of the consumer
•4. Normal persons.
5. Constant income – if income changes, he may go for a superior
brands

6. Uses of the law of DU
1. In determining the price of a commodity.
2. To explain the paradox of value- namely water- diamond paradox
• Water is plenty – so its relative MU is less
• So it has less price
• Diamond – scarce and its marginal utility is very high and hence
commands a price.
3. Explain the reason for the downward sloping of a DD curve.
4. In the field of taxation
• For rich people with high income, marginal utility of money is low.
• So higher tax on the rich.

7. Exceptions to the law of DU
•a. Alcoholics
•b. Misers
•c. Money
•d. Reading
•e. Hobbies and Rare collections
•f. Arts
The law of Equi-Marginal Utility
It states that the consumer would distribute his money income between
the goods in such a way that the utility derived from the last Rupee spent
on each good is equal. i.e.
MU of X = MU of Y = MU of Z
Price of X Price of Y Price of Z