Utility is the power or capacity of a

commodity to satisfy human wants.

As long as a commodity has some use i.e. , it
has the capacity to satisfy a person –it has
the UTILIY.
1. Utility is subjective (deals with mental
satisfaction)
2. Utility is Relative (does not remain
constant)
3. Not essentially useful.
1. Total Utility- TU refers to the entire
amount of satisfaction obtained from
consuming various quantities of a
commodity.
TUx = F(Qx)
2. Marginal Utility – MU is the increase in TU
which results from a unit increase in
consumption.
MU = ∆TU
----- or MU= TUn-TUn-1
∆Q
Q ($)TU ($) MU
0 0
1 40 40
2 85 45
3 120 35
4 140 20
5 150 10
6 157 7
7 160 3
8 160 0
9 155 -5
10 145 -10
145

5
 Total Utility

200
Q ($) TU ($) MU
150
0 0
100
1 40 40
50
2 85 45
0
1 2 3 4 5 6 7 8 9 10 11 3 120 35
4 140 20
5 150 10
($) M U
6 157 7
50
7 160 3
40

30
8 160 0
20 9 155 -5
10

0
10 145 -10
1 2 3 4 5 6 7 8 9 1 11
-10 145
-20

6
Approaches

Cardinal Utility (by Marshall) : According to this

approach Utility is measurable in terms of
liters, centimeters, kilograms, rupees etc.
Ordinal Utility (by Hicks) : According to this
approach consumer can rank their
preferences.
Cardinal Approach
This is a traditional approach and examines the consumer
behavior solely on the utility consideration.

Law of Diminishing Marginal Utility :

It states that “Other things remaining the same, as a
consumer increases his consumption of goods, the
Marginal Utility eventually starts declining”.

Suppose, you are extremely thirsty, a glass of water

certainly will have a high Marginal Utility. However, after 2
or 3 glasses of water the Marginal Utility inevitably starts
falling and Marginal Utility of 5 or 6 glasses of water at a
time may prove to be negative.
Assumptions of utility analysis
1. Cardinal Measurement of utility – quantifiable
2. Utility is additive.
3. Independent utilities – from amounts of other
products
4. MU of money remains constant
5. From own experiences it is possible to make
inferences about others.
6. It is assumed that the income and prices are
fixed.
7. Stability of tastes.
Exceptions:
1. When initial units of commodity are used in small
and less then appropriate quantity e.g. testing,
this does Before customer gets satisfactory
quantity, this does not apply.
2. Rare and Curious product like coins, rare
painting.
3. Drunkards
4. Misers – who want to acquire more and more
wealth.
5. Love of display, love of power
6. Good books, poems, music.
7. Large number of consumers.
Importance of law
1. law of demand – as larger quantities are bought
at lower price.
2. Importance for the consumers – they should buy
some unit of other products to maximize
satisfaction.
3. Variety in production
4. Helps in price determination
5. Bases of socialism – utility of money is great to
poor.
6. Bases of taxation.
Limitations
• It is based on the unrealistic assumption of cardinal
measurement of utility. Utility is a psychological
term which can not be measured in terms of
numbers and units.
• It is applicable only for one commodity.
• It does not explain the impact of the
complementary and substitute goods on the
demand.
• It can not explain the impact of changes in the
income on demand.
This law was propounded in 19th century by a
French engineer named as ‘Gossen’.

Statement of the law: ‘if a person has a thing

which he can put to several uses ,he will
distribute it among these uses in such a way
that it has the same marginal utility in all.’
 Consumer acts rationally
 Perfect knowledge
 Utility is quantifiable
 Independent utilities
 No change in income
 Goods are homogeneous and divisible
In the diagram doted line is showing the line of Equi-marginal utility
 Irrational Behavior
 Lack of complete knowledge
 Consumer is not calculating machine
 Utility is subjective
 Indivisible goods
 Durable goods
 Scarcity of goods
 Change in income, prices, tastes etc.
 Laziness of the consumer
 Importance in consumption
 Importance in production
 Importance in exchange
 Importance in distribution
 Importance in public finance
IC analysis refers to the locus of points
representing the various combinations of two
goods which yields the same level of
satisfaction to the consumer.
According to this analysis, utility can’t be
expressed in cardinal numbers because utility is
a psychological feeling.
Combination of Good X Good Y
Good X and Y

A. 1 30

B. 2 24

C. 3 19

D. 4 15

E. 5 12
 The family of indifference curve is known as
indifference map. In the indifference map a
higher indifference curve refers to a higher level
of utility.
 MRS of X is defined as the amount of Y, the
consumer is just willing to give up to get one
more unit of X and maintain the same level of
satisfaction.
Combination of Good X Good Y MRSxy
Good X an Y

A. 1 30

B. 2 24 6:1

C. 3 19 5:1

D. 4 15 4:1

E. 5 12 3:1
 According to this law, as a consumer gets more
and more units of X, he will be willing to give
up less and less units of Y. In other words, the
marginal rate of substitution of X for Y will go
on diminishing while the level of satisfaction
remains the same. Above table shows that
consumer will give up 6 units of good Y for
getting second unit of good X, 5 units good Y for
getting third unit of X and so on. In other words,
MRSxy goes on diminishing.
 1 Rationality- (maximum satisfaction)

 2Ordinal Utility-(consumer can rank his

preferences)

 3Diminishing marginal rate of

substitution(the rate at which certain amount
of one commodity is substituted for another
is called MRS)
4. Axioms of comparison-Any 2
combinations of X & Y commodities can be
compared in preference by an individual-
A) A is preferred to B.
B) B is preferred to A.
C) A&B are indifferent
 5.Consistency

 6. Transitivity- Assumes there are three

combinations of goods –A,B,C. If A is
preferred to B and B is preferred to C ,then A
must be preferred to C .

 7. Scale of preference independent of market

price.
 IC is downward sloping: This property implies that IC has a negative slope
means when the amount of one good in the combination is increase, the
amount of other good is reduced. This must be so if the level of satisfaction
is to remain the same on an IC. If an IC doesn’t slope downwards then it
can either be vertical, horizontal or upward sloping.
 Perfect Perfect
Complement Substitutes
QY QY
s

QX QX
PRICE LINE OR BUDGET LINE-

It shows all the different combinations of the

two commodities that a consumer can
purchase ,given his money income and the
price of the two commodities.
 It is a straight line.
 It has a negative slope.
 Its slope indicates ratio of prices of two
goods.
40
 Combination of goods that maximizes utility
for a given set of prices and a given level of
income
 Represented graphically by the point of
tangency between an indifference curve and
the budget line
◦ MUX/MUY = PX/PY
◦ MUX/PX = MUY/PY
1) Price line should be tangent to Indifference
Curve
2) Indifference Curve must be Convex to the
origin.
 Measurement of consumer’s surplus
 Producer’s Equilibrium
 Complete explanation of Demand
 Direct and Indirect Taxation
 Supply of Labor (at different wage levels)
 Effect on change in price index
 Effect of govt. policy on economic welfare.