Introduction of Utility analysis,its types, Law of diminishing Marginal Utility, Law of Equi marginal utility, Consumer surplus

1. UTILITY ANALYSIS
Dr. Ruchi Jain

2. Content
Utility Approach:
Meaning and Definition of Utility.
Characteristics of Utility.
Measurement of Utility. Total Utility
and Marginal Utility.
Law of Diminishing Marginal Utility,
Law of Equi-Marginal utility,
Limitations of Utility approach
Law of Consumer surplus (Marshall’s
version)

3. What is Utility?
 Product angle: Want satisfying property of any
product (absolute).
 Consumer angle: The psychological feeling of
satisfaction or happiness or well being or benefit
derived by the consumer by the consumption of
certain units of a good or service at a certain point
of time (subjective)

4. Utility can be measured in two ways:
➢ Cardinal Utility: Assigning numerical
values to the amount of
satisfaction.(cardinal numbers are
those definite numbers which can
be added or subtracted.)
➢ Ordinal Utility: Not assigning
numerical values to the amount of
satisfaction but indicating the order
of preferences, that is, what is

5. In twentieth century Marshall and
Pigou elaborated Cardinal Utility
Analysis.
Fisher has used the term ‘util’ as a
measure of Utility.

6. MEANING OF UTILITY
In the words of Hibbdon , “Utility is the
Quality of a good to satisfy a want.”
Thus we can say that wants satisfying
power of a commodity is called utility.

7. FEATURES OF UTILITY
 UTILITY IS SUBJECTIVE: It is subjective because it
deals with the mental satisfaction of a man.Eg.
Medical books re not useful for commerce
students.
 UTILITY IS RELATIVE: Utility of a commodity never
remains the same.it varies across the time and
place. E.g. Cooler has utility in the summer but
not during winter.
 UTILITY IS NOT ESSENTIALLY USEFUL:A commodity
having utility need not be useful. Liquor and
cigarette are not useful, but to satisfy the want
of an addict then they gave utility for him.
 UTILITY IS INDEPENDENT OF MORALITY: Utility has
nothing to do with morality.eg. Use of opium,
liquor

8. FEATURES OF UTILITY
 UTILITY CAN BE MEASURED: Marshall assumes cardinal
measurement of utility.’Utils’
 UTILITY DEPENDS ON THE INTENSITY OF WANT: A want which is
unsatisfied and greatly intense will imply a high utility for
commodity concerned to a person.
 UTILITY IS CONCERNED WITH CONSUMER GOODS NOT WITH
PRODUCTIVE GOODS: eg.atta in restaurants (productive goods)
does not give direct satisfaction to customers, at home
(consumer good)
 UTILITY HAS NO PHYSICAL SHAPE: It is psychological concept
and differs from person to person , place to place ad time to
time.
 UTILITY DOES NOT DEPEND ON ACTUAL CONSUMPTION:the utility
starts the moment when he consumer thinks of buying a
commodity and the satisfaction is derived after the
consumption of the commodity.

9. Assumptions
 Rational consumer
 Cardinal utility-Measured in cardinal numbers 1,2,3,4,5 etc.
 Independent Utility: it is assumed that the utility that a consumer
gets from a commodity depends upon the quantity of that
commodity itself.it is not affected by the utility derived from other
goods.
 Marginal Utility of money is constant
 Divisibility
 Diminishing marginal utility
 Total Utility Depends on quantities of Individual Commodities: if
there are ‘n’ commodities in the bundle with n1,n2,…nn
quantities the total utility is U=f(n1,n2,…nn )

10. Utility is of two types:
➢Total Utility
➢Marginal Utility

11. Total Utility
➢ Sum of utility derived by consumer
from multiple units Consumed at a
point or over a period of time
➢ Example: A consumer consumes 3
units of X and
derives utility u1, u2, u3 and u4
➢ Total Utility Ux= u1 + u2 + u3
➢ TUx= f(Qx)
➢ TU= ∑MU

12. Total Utility
 The total satisfaction of wants & needs obtained
from the consumption of goods & services
 Based on the presumption that the amount of
utility generated from the consumption of a
good can be explicitly measures
 Hypothetical measure is util
 TOTAL UTILITY: It is the sum total of utility derived
from the consumption of all units of a
commodity.

13. MARGINAL UTILITY
Marginal means change.
 It refers to the additional utility obtained due to
the consumption of an additional unit of a
commodity.
The change in total utility (∆TU) derived from
one additional unit of consumption (∆X)
MU = ∆ TU/ ∆ X
MU= TUn- Tun-1
Marginal utility can be (i) positive (ii) zero (iii)
negative.

14. Total Utility (TU) and Marginal Utility (MU)
Ice-creams
Consumed
Total Utility
(TUx)
Marginal Utility
(MUx)
1 20 20
2 36 16
3 46 10
4 50 4
5 50 0
6 44 -6

15. ➢ The first column is showing the unit of a commodity. Second
column of the above table gives and individuals hypothetical total
utility (tu) from consuming various alternative quantities of
commodity X . There it is noted that, as the individual consumes
more unit of X, Tux increases.
➢ The Third column of the table is showing the individuals marginal
Utility for commodity X. each value of column three is obtain by
subtracting two successive value of column two. For example, If the
individuals consumption of X goes from 1 unit to 2 units, the (Tux )
goes from 20 to 36 utilities, giving a MUx of 16. Similarly if the
consumption of X rises from 2 units to 3 units, the (Tux) rises from
36 to 46, giving a MUx from 16 to 10. From the table we can see
that as this individuals consumption more Units of X, MUx falls

16. Total Utility and Marginal Utility
curve

17. TU is maximum
Saturation point
TU
Y
X
Y
X
0
0
MU
+ve
MU = 0
MU (–)ve
MU

18. ➢ In Fig, units of ice-cream, are shown along the X-axis
and TU and MU are measured along the Y-axis. MU is
positive and TU is increasing till the 4th ice-cream. After
consuming the 5th ice-cream, MU is zero and TU is
maximum.
➢ This point is known as the point of satiety or the stage
of maximum satisfaction. After consuming the 6th icecream,
➢ MU is negative (known as disutility) and total
utility starts diminishing. Disutility is the opposite of
utility. It refers to loss of satisfaction due to
consumption of too much of a thing

19. RELATION BETWEEN TOTAL UTILITY
AND MARGINAL UTILITY
➢ Total utility is increasing at increasing
rate so long as marginal utility is
positive.
➢ Total utility becomes maximum when
marginal utility is zero.
➢ Total utility starts declining when
marginal utility is negative.

20. Significance of the difference
between Total Utility and
marginal Utility
 Paradox of Value or The Diamond –
Water Paradox-Total utility of Water is
more and marginal Utility of Diamond is
more. Value/Price is according to
marginal utility.
 Consumer’s surplus- Customer willing to
pay according to total utility but actually
pays according to marginal utility.
Difference between two is Consumer
Surplus.

21. LAW OF DIMINISHING
MARGINAL UTILITY:
 LAW OF DIMINISHING MARGINAL UTILITY:
It stated that as the consumer goes on
consuming more and more amount of
commodity the marginal utility of the
commodity goes on declining becomes
zero and finally becomes negative.
 As we go on consuming more and more
amount of commodity. The marginal
utility derived from it is declining
becomes zero and negative.

22. LAWS OF UTILITY ANALYSIS
UTILITY ANALYSIS
LAW OF
DIMINISHING
MARGINAL UTILITY
LAW OF
EQUI-MARGINAL
UTILITY

23. LAW OF DIMINISHING
MARGINAL UTILITY
It states that as the consumer goes on consuming
more and more amount of commodity the marginal
utility of the commodity goes on declining becomes
zero and finally becomes negative.
E.g. If you are set to buy ,say, fountain pens at and
given time, then as the number of pens with you
goes on increasing, the marginal utility from each
successive pen will go on decreasing.

24.  “As the quantity consumed of a commodity
 goes on increasing, the utility derived from
 each successive unit goes on diminishing,
 consumption of all other commodities
 remaining the same” When the changes in
 consumption are infinitely small, marginal
 utility is the derivative of total utility.
 MU = dTU/dX

25. ASSUMPTIONS
Utility can be measures in the cardinal number system.
Marginal utility of money remains constant.
Marginal utility of every commodity is independent.
Every unit of the commodity being used is of same quality and size.
There is a continuous consumption of the commodity.
Suitable quantity of the commodity is consumed.
There is no change in the income of consumer, price of the
commodity and its substitutes.
There is no change in the tastes, character, fashion and habits of
consumer.

26. Example
• As an example assume you have one ice cream
• 1 Ice Cream you feel Ecstatic

27. You have a second Ice cream
2nd Ice Cream, u still feel Ecstatic

28. You have a Third Ice cream
3 rd Ice Cream, u feel very happy

29. You have a Fourth Ice cream
4th Ice Cream, u feel happy

30. You have a Fifth Ice cream
5th Ice Cream, u still feel happy

31. You have a Sixth Ice cream
6th Ice Cream You are not so Happy

32. You have a Seventh Ice cream
7th Ice Cream You are not so Happy

33. You have a Eighth Ice cream
8th Ice Cream You fall sick.

34. The following table will make the law of
diminishing marginal
utility more clear
Units Total Utility Marginal Utility
1st ice cream 20 20
2nd ice cream 32 12
3rd ice cream 40 8
4th ice cream 44 4
5th ice cream 45 1
6th ice cream 45 0
7TH ice cream 42 -3
8th ice cream 40 -2

36.  It is evident from the
table and diagram that
first cup of ice cream
yield 30 utils thus higher
satisfaction and with
consumption of more
and more units of ice
cream, MU from each
successive unit goes on
diminishing.
1 2 4 53 6
4
3
2
1
O
-1
B
Y
A
+ve
-ve
X
C
QUANTITY
UTILITY
M.U.
CURVE
Point of
saturation
Zero
M.U.

37. We can say that the law of
diminishing utility, like other
laws of Economics, is simply a
statement of tendency. It
holds good, provided other
factors remain constant.

38. EXCEPTIONS
 Curious and Rare Things: Law does not these things.
Those persons who collect old and rare coins
,postage stamps etc derive increasing marginal
utility as the stock of these rare articles goes on
increasing.
 Misers: It seems as if the law does not apply to
misers, who are out to acquire more and more of
wealth. Their desire for money seems to be
insatiable.
 Good Book or Poem: Reading a good book or
listening to a melodious song or beautiful poem
again and again, one gets more utility than before
so these also exceptions to this law.
 Drunkards: When drunkards takes more and more
pegs of liquor his desire to have more of it goes on
increasing.
 Initial units: when the initial units of a commodity are
used in less than the appropriate quantity, then MU
from the additional units goes on increasing.

39. CAUSES OF ITS APPLICATIONS
Commodities are Imperfect
Substitutes: tea in place of coffee
and coffee in place of tea cannot
be used to unlimited extent.
Satiability of Particular Wants:
Alternative Uses: Each and every
commodities have more than one
uses. E.g. electricity

40. LIMITATIONS OF THE LAW
 Suitable units:- It is assumed that the
commodity is taken in suitable units.
 Suitable time:-It is further assumed that the
commodity is taken within a certain time,
otherwise law will not apply.
 No change in consumer’s tastes:-Another
assumption is that the character of the
consumers does not change.
 Normal persons:- The law of diminising
marginal utility applies to normal persons
and not to eccentric or abnormal persons
like misers.

41.  Constant income:-it is also essential that the income
remains the same. Any change in income will falsify
the law.
 Rare collections:- In case of rare collections ,the law
does not hold good.
 Fashion:- Further, fashion utility depends on fashion
too.

42. IMPORTANCE OF THE LAW
 Basis of the Laws of Consumption: Law of diminishing
marginal utility is the basis of all laws of
consumption.(1) Law of equi -marginal utility.(2)Law of
demand and (3) Concept of Consumer’s Surplus.
 Variety in Production and Consumption: It is because
of the operation of law of diminishing marginal utility.
Continuous consumption of one commodity will yield
less and less M.U. to the consumer. So the producers
will have to produce different varieties of goods.
 Basis of progressive taxation : In this direct taxes
come.
 Advantage to the consumer: Due to law of
diminishing M.U a consumer always buys till that point
where P=M.U.
 Difference between Value-in Use and Value-in-
Exchange.
 Price Determination
 Basis of re– distribution.

43. Derivation of Demand Curve with the help of
Law of Diminishing Marginal Utility
 The price that a consumer pays for a commodity is equal to its marginal
utility. As a consumer goes on purchasing more and more units of a
commodity, its marginal utility goes on diminishing.

44. M1
M2
M3
P1
P2
P3
-ve M.U.
QUANTITY
Q1 Q2Q3Q1 Q2 Q3
DEMAND
CURVE

45. CRITICISM
 Cardinal measurement of utility is not possible: It cannot be measured in
cardinal numbers because it is subjective concept.
 Every commodity is not independent commodity: Example – Car and
Petrol.
 Marginal Utility cannot be estimated in all conditions.
 Unrealistic Assumptions.
 Marginal utility of money is not constant.

46. Law of Equi Marginal Utility
 Second law of Gossen
 This law points out how a consumer can get maximum
satisfaction out of his expenditure on different goods.
 Marshall called it law of equi marginal utility.
 The law states that in order to get maximum satisfaction,
a consumer should spend his limited income on different
commodities in such a way that the last rupee spent on
each commodity yields him equal marginal utility.
 According to the law of equi marginal Utility , other things
being equal , a consumer maximising his utility will spend
his income among different goods in such a manner that
the utility derived from the last unit of money spent on
each good is equal.

47. • According to samuelson , “ A consumer gets maximum satisfaction
when the ratio of marginal utilities of all commodities and their price is
equal.”
• MU1 = MU2 = MU3
________ ________ ______
P1 P2 P3
If prices of the commodities are equal , the maximum satisfaction to the
consumer can be indicated in the following equation:
MU1 = MU2 = MU3
Here, MU1 Mu2 and MU3 refers to the marginal utility of first,
second and third commodity and P1,P2 and P3 refers to price
of first, second and third commodity.

48. ASSUMPTIONS Cardinal measurement of utility is possible.
 Consumer is relation , that is, he wants maximum satisfaction from
his income.
 Income of the consumer remains constant. Income of the consumer is
fixed and constant.
 Marginal Utility of money remains constant.
 Prices of the commodities remain constant.
 Commodity is divisible into small units. Its means that the consumer
can spend his income in small units of money , say , one rupee.
 Consumption takes places at a given time period.

50. IMPORTANCE OF THE
LAW Consumption
 Production
 Exchange
 Distribution
 Public Finance
 Distribution of Income between Saving and Consumption
 Optimum Distribution of Commodities
 Distribution of Assets

51. CRITICISM OF THE
LAW
 Consumer are not fully rational
 Consumer is not Calculating
 Shortage of Goods
 Influence of Fashion, Customs and Habits
 Ignorance of the Consumer
 Indivisibility of Goods
 Constant Income and Price
 Cardinal Measurement of Utility of Money
 Complementary Goods

52. COMSMER’S EQUILIBRIUM
 Consumer’s equilibrium refers to a situation wherein a consumer gets
maximum satisfaction out of his limited income and he has no tendency to
make any change in his existing expenditure.
 In the words of TIBER SCITOVOSKY “A consumer is in equilibrium
when he regards his actual behaviour as the best possible under the
circumstances and feels no urge to change his behaviour as long as
circumstances remain unchanged”

53. ASSUMPTIONS
 Consumer is assumed to be rational.
 Marginal utility of Money is Constant.
 Fixed price and Income.
 Tastes are constant.
 Perfect knowledge
 Independent utility
 Cardinal Utility

54. Determination of Consumer’s
Equilibrium
 A single commodity with one use.
 A single commodity with several uses.
 Several commodities.

55. Single commodity with one use-
When a consumer buys a commodity, he pays a price for it. For each
unit of the commodity he makes a sacrifice in terms of price. In
returns he gets some utility from each unit. By the law of diminishing
marginal utility, the utility of each successive unit goes on
diminishing as more and more units of a commodity are consumed.
The utility of money paid in terms of price of each unit of commodity
remains constant.
A rational consumer will consume the commodity upto a point where
the MU of the final unit of the commodity is equal to the MU of
money (in terms of price) paid for it. The consumer will get maximum
satisfaction and will be in equilibrium. (where MU =price)

56. Consumer’s Equilibrium in case of one commodity
with one use
Unit of ‘x’ (1) M.U. of ‘x’ (2) Utility of ‘x’
sacrificed in
terms of Price of
‘x’ (3)
surplus( 2-3)
1 50 20 30
2 40 20 20
3 30 20 10
4 20 20 0
5 10 20 -10

58. A single Commodity with several Uses-
 In case of a single commodity with
several uses, a consumer will be in
equilibrium when he distributes
different uses in such a way that he
gets equal marginal utility from each
use.
 MU (A) use= MU (B) Use

59. Consumer’s equilibrium in case of Single Commodity
with Several uses
Quantity of Oil (in
litres )
M.U. of Oil in stoves M.U. of Oil in
Lantern
1 10 8
2 8 6
3 6 4
4 4 2
5 2 1

61. SEVERAL COMMODITIES-
When a consumer spends his fixed income on more than one
commodity, he compares the marginal utilities of different
commodities with a view to getting maximum satisfaction. He
spends a unit of money on that commodities which gives him more
M.U.
The consumer stops the purchase of a commodity when its M.U
becomes less than M.U of another commodity. He will then shift
his purchase to other commodity.
He arrives at a situation where the last unit of money spent on
different commodities yields him equal M.U. This will be the
position of his equilibrium. A consumer will have mo desire to
make any change in this position, as he gets maximum
satisfaction.

62. Consumer’s Equilibrium-
Several Commodities
Rupee Spent M.U. of X
Commodity
M.U. of Y
Commodity
1 12 10
2 10 8
3 8 6
4 6 4
5 4 2

64. Criticism of Cardinal Utility Analysis
 Utility is Subjective.
 Cardinal measurement of utility is not possible.
 Every commodity is not an independent commodity.
 Marginal utility cannot be estimated in all conditions.
 Marginal utility of money does not remain constant .
 No division of Price effect between Income Effect and Substitution
Effect.
 Utility analysis breaks down in an under- developed Planned
Economy.
 Consumer is regarded as a computer.

65. Consumer Surplus
Consumer Surplus - the difference
between the price buyers pay for a
good and the maximum amount
they would have paid for the good.
Example:
• I’m willing to pay Rs.6 for a case of
orange
• Orange is on sale for Rs.5 a case
• Consumer surplus = Rs.1

66. Consumer Surplus
The difference between what a
consumer is willing to pay for an
addition unit of a good and the
market price that he/she actually
pays is referred to as “consumer
surplus”.
The area between the demand
curve and the price (line) measures
the total consumer surplus.

67. Consumer Surplus
S
D
Q
P
0
Rs5
31 2
Rs.9
Rs.7
This is the Consumer
Surplus for the
second case of Orange

68. Consumer Surplus
Here is the generally
accepted method of finding the
total Consumer Surplus in
a market

69. Consumer Surplus
S
D
Q
P
0
Q*
P*
The area of this
triangle is the total
Consumer Surplus

70. THE
END