Concept of Utility

Dr Onkarnath
Utility is defined as
• "The power of a commodity or service to satisfy human want".

• Utility is thus the satisfaction which is derived by the consumer by

consuming the goods.

For example, cloth has a utility for us because we can wear it. Pen has
a utility who can write with it. The utility is subjective in nature. It
differs from person to person. The utility of a bottle of wine is zero for a
person who is non drinker while it has a very high utility for a drinker.
Dr. Marshall states the law thus:

“The additional benefit which a person derives from a given increase of

his stock of anything diminishes with the growth of the stock that he

has.” In this statement of the law, the word “Additional” is very

important. It is only additional (marginal) benefit which decrease and

not the total benefit

(1) No. of Rasgullas (3) Marginal Utility Total Utility (2)

1 15 15
2 13 28
3 10 38
4 8 46
5 4 50
6 2 52
7 0 52
8 -2 50
9 -5 45
OX and OY are the two axes. Along OX are

represented the units of the commodity,

‘rasgullas’, and along OY is measured the

marginal utility corresponding to the

consumption of each unit; UU’ is the utility curve.

AB is the utility when one ‘rasgulla’ is taken. CD is

the additional utility when two of them are

taken: CD is less than AB. The additional utilities

of other successive Units are EF, GH. KL and MN.

 CLASSIFICATIONS OF UTILITY
• Initial Utility:

It is the utility of the initial or the first unit. In the table given on the previous page, the initial utility is 15.

• Total Utility:

Look at column 3 of the table. It gives the total utility at earn step. For example, if you consume one

‘rasgulla’, the total utility is 15; if you consume two, the total utility is 28, and so on.

• Zero Utility:

When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of

zero utility. In our table, the total utility, after the 6th unit is consumed, is 52. At the seventh also it is 52.

Thus, the seventh ‘rasgulla results’ in no increase whatsoever. This is the point o’ zero utility, it is thus seen

that the total utility is maximum when the marginal utility is zero.

• Negative Utility:

If the consumption of a commodity is carried to excess, then instead of giving any satisfaction, it may cause

dissatisfaction. The utility in such cases is negative. In the table given above the marginal utility of the 8th

and the 9th units is negative

Characteristics of Utility:
• 1. Utility has no Ethical or Moral Significance:
• 2. Utility is Psychological
• 3. Utility is always Individual and Relative
• 4. Utility is not Necessarily Equated with Usefulness
• 5. Utility cannot be Measured Objectively
• 6. Utility Depends on the Intensity of Want
• 7. Utility is Different from Pleasure
• 8. Utility is also Distinct from Satisfaction
 Types of utility
• 1. Form Utility: This utility is created by changing the form or shape of the materials. For example—A
cabinet turned out from steel furniture made of wood and so on. Basically, from utility is created by the
manufacturing of goods.

• 2. Place Utility: This utility is created by transporting goods from one place to another. Thus, in
marketing goods from the factory to the market place, place utility is created. Similarly, when food-
grains are shifted from farms to the city market by the grain merchants, place utility is created.

• 3. Time Utility: Storing, hoarding and preserving certain goods over a period of time may lead to the
creation of time utility for such goods e.g., by hoarding or storing food-grains at the time of a bumper
harvest and releasing their stocks for sale at the time of scarcity, traders derive the advantage of time
utility and thereby fetch higher prices for food-grains. Utility of a commodity is always more at the time
of scarcity. Trading essentially involves the creation of time utility.

• 4. Service Utility: This utility is created in rendering personal services to the customers by various
professionals, such as lawyers, doctors, teachers, bankers, actors etc.
CARDINAL UTILITY
• The Cardinal Utility approach is propounded by neo-classical
economists, who believe that utility is measurable, and the customer
can express his satisfaction in cardinal or quantitative numbers, such
as 1,2,3, and so on.

• And to do so, they have introduced a hypothetical unit called

as “Utils” meaning the units of utility. Here, one Util is equivalent to
one rupee and the utility of money remains constant.
The two laws
With the above basic premises, the founders of cardinal utility analysis
have developed two laws which occupy an important place in economic
theory and have several applications and uses.

These two laws are:

• Law of Diminishing Marginal Utility; and

• Law of Equi-Marginal Utility.

Law of Diminishing Marginal Utility
Marshall who has been a famous exponent of the cardinal utility
analysis has stated the law of diminishing marginal utility as follows:
Diminishing Marginal Utility
Limitations or Exceptions
• Dissimilar Units
• Very Small Units
• Too Long an Interval
• Rare Collections
• Abnormal Persons
• Change in another Person’s Stock
• Changes in Income, Habits and Tastes
EQUI MARGINAL UTILITY
Other names

• Gossens law

• Law of maximum satisfaction

The law
• The law of equi-marginal utility states that the consumer will
distribute his money income between the goods in such a way that
the utility derived from the last rupee spend on each good is equal.
• In other words, consumer is in equilibrium position when marginal
utility of money expenditure on each goods is the same.
 Utils Marginal utility

Units Good day (Re 10) Dairy milk (Re 5) Mux/Px Muy/Py

1 100 35 10 7

2 90 30 9 6

3 80 25 8 5

4 70 20 7 4

5 60 15 6 3

6 50 10 5 2
ORDINAL UTILITY
➢Ordinal Utility is propounded by the modern economists, J.R. Hicks,
and R.G.D. Allen.
➢ It states that, it is not possible for consumers to express the
satisfaction derived from a commodity in absolute or numerical
terms, and thus it cannot be measured quantitatively, theoretically
and conceptually.
➢However, a person can introspectively express whether a good or
service provides more, less or equal satisfaction when compared to
one another.
➢In this way, the measurement of utility is ordinal, i.e. qualitative.
➢Ranking of preferences for commodities.

For example: Suppose a person prefers tea to coffee and coffee to milk.
Hence, he or she can tell subjectively, his/her preferences, i.e. tea >
coffee > milk.
INDIFFERENCE CURVE ANALYSIS
• The indifference curve analysis approach was first introduced by
Slustsky, a Russian Economist in 1915. Later it was developed by J.R.
Hicks and R.G.D. Allen in the year 1928

• The indifference curve indicates the various combinations of two

goods which yield equal satisfaction to the consumer.

• By definition: "An indifference curve shows all the various

combinations of two goods that give an equal amount of satisfaction
to a consumer".
 For example, a person has a limited amount of income which he wishes
to spend on two commodities, rice and wheat. Let us suppose that the
following commodities are equally valued by him:

Various Combinations:

a) 16 Kilograms of Rice Plus 2 Kilograms of Wheat

b) 12 Kilograms of Rice Plus 5 Kilograms of Wheat

c) 11 Kilograms of Rice Plus 7 Kilograms of Wheat

d) 10 Kilograms of Rice Plus 10 Kilograms of Wheat

e) 9 Kilograms of Rice Plus 15 Kilograms of Wheat

An Indifference Map
Marginal Rate of Substitution (MRS)
• An indifference curve is formed when one good is substituted for
other. Marginal Rate of Substitution (MRS) refers to a rate at which
one good is substituted for other, while keeping the level of
satisfaction of a consumer constant. In other words, MRS between
two goods X and Y is defined as the quantity of X which is required to
replace Y or quantity of Y required to replace X, so that the total
utility remains same.
It is expressed as:
MRS x,y = ∆Y/∆X
MRS is called the slope of indifference curve.
Concept of Budget Line:
Budget Line
Effect on Budget Line when Income Changes
Effect on Budget Line when Price Chanaes