Utility Theory in Economics
Dr. Bharti Shukla
Assistant Professor
MSD
MMMUT, GKP
Topic to be covered
1.
Utility
2.
Cardinal Utility
3.
Law of Diminishing Marginal Utility
4.
Ordinal Utility
5.
Indifference Curve Analysis
Consumer
Theory
A
consumer
usually
decides
his
demand
for
a
commodity
on
the
basis of utility (or
satisfaction) that he derives from it. What is
utility?
Utility
of
a
commodity
is
its
want-satisfying
capacity.
The
more
the
need
of
a
commodity
or
the
stronger
the
desire
to
have
it,
the
greater
is
the
utility
derived
from
the
commodity.
About Utility
Utility
is
subjective.
Different
individuals
can
get
different
levels
of
utility
from
the
same
commodity.
For
example,
some
one
who likes chocolates
will get much higher utility from a chocolate
than some one
who
is
not
so
fond
of
chocolates,
Also,
utility
that
one
individual
gets
from
the
commodity can change with change in place
and time.
For example, utility from
the
use
of
a
room
heater
will
depend
upon
whether
the
individual
is
in
Ladakh
or
Chennai
(place)
or
whether
it
is
summer
or
winter
(time).
Features
1.
Subjective
2.
It is relative
3.
Does not state usefulness
4.
No ethical, legal or moral connotations
Two Types of Utility
Cardinal
utility
Cardinal
utility
analysis
assumes
that
level
of
utility
can
be
expressed
in
numbers.
For
example,
we
can
measure
the
utility
derived
from
a
shirt
and
say,
this
shirt
gives
me
50
units
of
utility.
Before
discussing
further,
it
will
be
useful
to
have
a
look
at
two
important
measures
of
utility.
Measurement of Utility
Values of marginal and total utility derived from consumption
of
various
amounts
of
a
commodity
The values of marginal and total
utility derived from
consumption of various amounts
of a commodity. The marginal
utility diminishes with increase
in consumption of the
commodity.
Explanation of
Utility Table and
Diagram
Notice that MU
3
is less than MU
2
. You may also notice
that total utility increases but at a Diminishing rate: The rate
of change in total utility due to change in quantity of
commodity consumed is a measure of marginal utility. This
marginal utility diminishes with increase in consumption of
the commodity from 12 to 6, 6 to 4 and so on. This follows
from the law of diminishing marginal utility.
MU
becomes
zero
at
a
level
when
TU
remains
constant.
In
the
example,
TU
does
not
change
at
5
th
unit
of
consumption
and
therefore
MU
=
0.
Thereafter,
TU
starts
falling
and
MU
becomes
negative.
Law
of
Diminishing
Marginal
Utility
Law
of
Diminishing
Marginal
Utility
states
that marginal utility from
consuming each additional unit of a
commodity declines
as its consumption
increases, while keeping consumption of
other commodities
constant.
Assumptions
1.
Units should be homogeneous
2.
Consumed in quick succession
3.
Standard in size
4.
Taste should be constant
5.
No change in price of substitute
6.
Utility is measurable
7.
Consumer is expected to be rational
Limitations
1.
Dissimilar units
2.
Too long an interval
3.
Abnormal People
4.
Rare Collection
5.
Not Applicable to Money
Utility theory in economics explores the concept of utility, which refers to the satisfaction or want-satisfying capacity a commodity provides to consumers. It is subjective, relative, and can vary among individuals. Cardinal utility analysis quantifies utility in numbers, while total utility and marginal utility measure the overall satisfaction derived from consuming commodities. The level of utility can change based on place and time, and individuals may have different preferences for the same commodity.
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Presentation Transcript
Topic to be covered Dr. Bharti Shukla Assistant Professor MSD MMMUT, GKP 1. Utility 2. Cardinal Utility 3. Law of Diminishing Marginal Utility 4. Ordinal Utility 5. Indifference Curve Analysis
A consumer usually decides his demand for a commodity on the satisfaction) that he derives from it. What is utility? basis of utility (or Consumer Theory Utility of a commodity is its want-satisfying capacity. The more the need of a commodity or the stronger the desire to have it, the greater is the utilityderived fromthe commodity.
Utility is subjective. Different individuals can get different levels of utility from the same commodity. For example, some one who likes chocolates will get much higher utility from a chocolate than some one who is not so fond of chocolates, About Utility Also, utility that one individual gets from the commodity can change with change in place and time. For example, utility from the use of a room heater will depend upon whether the individual is in Ladakh or Chennai (place) or whether it is summer orwinter (time).
1. Subjective 2. It is relative 3. Does not state usefulness Features 4. No ethical, legal or moral connotations
Cardinal utility analysis assumes that level of utility can be expressed in numbers. For example, we can measure the utility derived from a shirt and say, this shirt gives me 50 units of utility. Before discussing further, it will be useful to have a look at two important measures of utility. Cardinal utility
Total Utility: Total utility of a fixed quantity of a commodity (TU) is the total satisfaction derived from consuming the given amount of some commodity x. More of commodity x provides more satisfaction to the consumer. TU dependson the quantity of the commodity consumed. Therefore, TUn refers to total utility derived from consuming n units of a commodity x. Marginal Utility: Marginal utility (MU) is the change in total utility due to consumption of one additional unit of a commodity. For example, suppose 4 bananas give us 28 units of total utility and 5 bananas give us 30 units of total utility. Clearly, consumption of the 5thbanana has caused total utility to increase by 2 units (30 units minus 28 units). Therefore, marginal utility of the 5thbanana is 2 units. MU5 = TU5 TU4 = 30 28 = 2 Measurement of Utility
Units Total Utility Marginal Utility 1 12 12 2 18 6 3 22 4 4 24 2 5 24 0 6 22 -2 Values of marginal and total utility derived from consumptionofvarious amountsof acommodity
The values of marginal and total utility derived consumption of various amounts of a commodity. The marginal utility diminishes with increase in consumption commodity. from of the
Notice that MU3 is less than MU2. You may also notice that total utility increases but at a Diminishing rate: The rate of change in total utility due to change in quantity of commodity consumed is a measure of marginal utility. This marginal utility diminishes with increase in consumption of the commodity from 12 to 6, 6 to 4 and so on. This follows from the law of diminishing marginal utility. MU becomes zero at a level when TU remains constant. In the example, TU does not change at 5th unit of consumption and therefore MU = 0. Thereafter, TU starts falling and MU becomes negative. Explanation of Utility Table and Diagram
Law of Diminishing Marginal Utility states that marginal utility from consuming each additional unit of a commodity declines as its consumption increases, while keeping consumption of other commodities constant. Law of Diminishing Marginal Utility
1. Units should be homogeneous 2. Consumed in quick succession 3. Standard in size 4. Taste should be constant Assumptions 5. No change in price of substitute 6. Utility is measurable 7. Consumer is expected to be rational
1. Dissimilar units 2. Too long an interval 3. Abnormal People Limitations 4. Rare Collection 5. Not Applicable to Money
