Utility

Utility

Alfred Marshall (1842-1924) J.R. Hicks (1904−1989)

Prof. Alfred Marshall was educated Prof. J.R. Hicks was educated at Oxford
Cambridge. He belongs to the Classical and he lectured at the London School of
School of Economics and he is well Economics (1926-1935). He was awarded
known for refining Micro-Economic the Nobel Prize for Economics in 1972. He
Theory. He created the expression popularized the use of the Indifference
"Elasticity" to describe the Curve Technique for analyzing consumer
responsiveness of demand to changes in behavior. He propagated the use of the
price. He also considers demand and ordinal measurement for utility analysis.
supply to work like a pair of scissors to
determine prices. The term "Quasi-
Rent" was coined by him.

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 Utility

WHAT
The term ‘utility’ means the want-satisfying capacity of a commodity.

FEATURES

1. Utility is a subjective concept:

Utility is a psychological concept and so it’s want satisfying capacity cannot be of
the same intensity for all the consumers of a particular commodity. Hence, utility is
subjective. For instance, a walking stick would be very useful to an old person for
walking but it would not serve the same purpose for a younger and an abler person.
2. Utility is a relative concept:
Utility of a commodity would change from place to place and from time to time.
Hence, it is relative. For instance, water’s utility in a farm would differ from its utility
in a kitchen; or, woollen clothing’s utility is optimized in winter and not in summer.
3. Utility is an amoral concept:
Utility is confined only to the satisfaction of wants and so utility does not involve
itself with the morality aspects of the consumption of a commodity. For instance,
alcohol to an alcoholic would have utility because it satisfies his want, although it
can cause physical damage. Thus, utility should not be equated with usefulness,
satisfaction or pleasure. (Refer to the differences between utility and the above terms)
4. Utility is not objectively measurable:
Since utility is a subjective concept, it cannot be measured directly or precisely in
real cardinal terms. In fact, according to Prof. Hicks, utility can be measured only in
ordinal terms. Marshall assumes utility can be cardinally measured.
5. Utility is the basis of demand.
People demand goods and services only if they possess utility for them.
6. Utility is multipurpose.
The same commodity can satisfy different wants for different people – e.g., coal can
be used in industrial furnaces or as a fuel for cooking or for running steam engines.
7. Utility is abstract.
Utility per se cannot be seen, touched or felt.
8. Utility can be distinguished into the following types:
a. Time Utility (Temporal Utility):
This refers to that situation in which the want satisfying power of commodity
changes with time, e.g., a raw fruit ripens over a definite period of time and this
gives greater utility to the consumer. But, if it is kept over the appropriate time
period, there is always the possibility of its utility decreasing, as the fruit can get
rotten (leading to disutility).
b. Place Utility (Locational / Spatial Utility):

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 Utility

The want satisfying power of a commodity changes when the place of its
consumption changes, e.g., a thick fur coat would give the wearer high utility in the
Polar region, but in the Tropics, it would give the wearer discomfort and irritation
(i.e., disutility).
c. Form Utility (Structural Utility):
The want satisfying power of a commodity changes when a transformation takes
place in its structure and appearance, e.g., a log of wood could provide fuel material
to a person needing fire, but if this log of wood is cut into planks and made into a
table, then its utility would be different.
d. Service Utility (Intangible Utility):
The want satisfying power of a situation changes when a transformation takes place
in its intangible aspects, e.g., the services of a doctor can transform a sick person
into a healthy one.

Ordinal measurement Cardinal measurement

what
It refers to that mode of measurement It refers to that mode of measurement
wherein exact quantification is not possible wherein exact, precise and definite
but comparisons can establish a sense of quantification takes place.
quantification.
usefulness
It is useful mainly for measuring social and It is useful more in the natural sciences
psychological concepts because they tend where the concept behaves uniformly all
to be subjective and relative. the time. e.g. distance, speed, weight
miscellany
i. It is used by Prof. J.R. Hicks in the i. It is used by Prof. Marshall in his
analysis of utility. analysis of utility.
ii. It is a superior way for measuring ii. It is an inferior way in measuring utility
utility because it acknowledges that as it ignores the psychological nature of
utility is subjective. utility.

Utility Pleasure
what
It is the want-satisfying capacity of a It is the psychologically gratifying capacity
commodity. of a commodity.
illustration
A bitter medicine gives the patient utility. That bitter medicine may not give the
patient any pleasure while it is being
consumed.
Utility Satisfaction
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 Utility

what
It is the want-satisfying power of a It is the amount of psychological benefit
commodity. which an individual derives from a good.
inter-relationship
It is the anticipation of satisfaction - i.e., it It is the actual realization of a
is a potential ‘satisfier’. psychological benefit.
illustration
A motor-car possesses utility because it The motor-car satisfies the individual when
can help a person in transporting himself. it actually transports the person.

Utility Usefulness
what
It is the want-satisfying capacity of a It is only the beneficial aspect of a
commodity. commodity.
illustration
Alcohol gives an alcoholic great utility. Alcohol has a questionable usefulness vis-
à-vis the alcoholic’s health.

Utility Disutility
what
It is the want satisfying capacity of a good. It is the dissatisfying capacity of a good.
Numerical Value
The MU value is always positive and so The MU value is always negative and so it
causes the TU to rise. causes the TU to fall.
Graphical display

MU, TU

TU Curve

Utility

Qty
Disutility
MU Curve

Illustration
When a particular food item is eaten in the When a particular food item is eaten in an
right amount, the consumer enjoys excess amount, the consumer experiences
utilities from these units of consumption. disutilities from these units of consumption.

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 Utility

THEORETICAL ASPECTS OF UTILITY

1. Marginal Utility :
It is the utility derived by consuming an additional unit of the given commodity.
2. Total Utility :
It is the sum total of the marginal utilities derived at a particular level of consumption.

DIFFERENCES BETWEEN MU AND TU :

Marginal Utility Total Utility

what
It is the additional utility derived by It is the sum total of the utilities derived at
consuming one more unit of the a particular level of consumption.
commodity.
formula
n
MUn = TUn – TU(n–1) TUn =  MU
1
graphical depiction
MU Curve TU Curve
MU TU

Qty Qty

graphical comment
The MU curve continuously falls and The TU curve initially rises, peaks at a
exists in the first and fourth quadrants. particular point and then begins to decline.
It exists only in the first quadrant.
numerical value
Numerically, it can be positive, zero or Numerically, it is always positive.
negative.

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 Utility

RELATIONSHIP BETWEEN MU AND TU :

Units T.U. M.U. TU

& D
1 50 50 MU
E
2 90 40 TU Curve
3 120 30
A
4 130 10
5 130 0
6 100 –30 B
Quantity
C
MU Curve

The TU at the first level of consumption is the same as the MU at the 1st unit. The TU at
the second unit of consumption is MU1 + MU2 (i.e. 50 + 40 = 90) and so on for the other
levels of consumption.
The TU Curve is an inverted U-shaped one, as it moves upwards initially, reaches a peak
and then it begins to decline. This happens because after the POINT OF SATIETY (where
MU = 0), the consumer begins to experience disutilities (negative utilities). The TU
increases at a decreasing rate because the MU diminishes with every additional unit of
consumption. The MU curve is therefore always downward sloping and after intersecting
the X-axis (ie, MU = 0) it enters the fourth quadrant (i.e. MU becomes negative). This
tendency of the MU is due to the operation of the Law of Diminishing Marginal Utility.

Marginal Utility Total Utility

Positive (AB) Rises (AD)
Zero (point B) Reaches its peak (pt. D)
Negative (BC) Declines (DE)

THE LAW OF DIMINISHING MARGINAL UTILITY (DMU)

(The Law of DMU was first given by a French Engineer Gossen. It’s also known as
Gossen’s First Law.)
Statement
‘Every thing else remaining constant, the additional benefit which a person derives from a
given increase of his stock of a thing, diminishes with every increase in the stock that he
already has’. - Prof. Alfred Marshall

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 Utility

Assumptions
1. The units of the commodity consumed are homogeneous:
Every unit must have the same colour, shape, size, taste, etc. This assumption is
needed so that we deal with the same type of commodity all the time.
2. The size of the units consumed must be normal:
If the unit of consumption is much larger than usual, then the individual will not be
able to consume an adequate number of units to test the validity of the law. Again, if
the unit of consumption is too small, then the individual will naturally get a greater
amount of satisfaction with every additional unit consumed, thus invalidating the law.
3. The time interval between the consumption of successive units must be normal:
If the time gap is too long, then the individual would get greater satisfaction with
every additional unit consumed. On the other hand, if the time gap is too short, then
the individual would not be able to consume an adequate amount to validate the law.
4. Economic Rationality:
By this is meant that the concerned individual will consume the commodity in order
to maximize his satisfaction, given his income and other relevant factors.
5. Cardinal Measurement:
It is assumed that utility can be cardinally measured - i.e., it can be exactly and
precisely measured. The unit for measuring utility is known as UTILS.
6. MU of Money:
The MU of money is assumed to be constant. This is needed since Marshall measured
the MU of goods in terms of money. If the money, which is the unit of measurement,
varies as one is measuring with it, it cannot then yield a correct and definite
measurement of the MU of goods.
7. Ceteris Paribus:
Ceteris paribus means ‘other relevant things remaining constant’ i.e., other relevant
factors like the consumer’s tastes, income, preferences, fashions and so on, vis-à-vis
the consumer and the commodity must remain unchanged or else the economic
tendency which the law claims, will not hold true. This assumption is needed since
utility is a psychological and hence a subjective concept.
Schedule Graph
Units T.U. M.U. TU
1 50 50 &
MU
2 90 40
3 120 30
4 130 10
5 130 0
6 100 –30
Quantity
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 Utility

Explanation
In the above situation, it will be noticed that the first unit of consumption gives the
consumer 50 utils. But as the consumer increases his consumption, the MU derived keeps
decreasing, e.g., at the fourth unit of consumption the consumer’s MU has declined to
only 10 utils and at the fifth unit of consumption his MU is zero. Any further consumption
gives him disutilities.
The MU derived lessens with every successive unit of consumption because the
individual’s desire to consume more and more of the same commodity diminishes with
every additional unit consumed. Utility being a psychological concept, it is only natural
that the individual’s desire to consume more of the same commodity reduces with every
successive unit consumed, as the consumer gets bored due to the monotony that sets in.
For instance, the first unit of a sweet gives the consumer the greatest satisfaction. But as
more and more of the same type of sweet are consumed, some sort of a dislike towards
this sweet develops within the consumer's mind. Thus, the individual’s satisfaction level
falls as more of the same sweet is consumed.

Exceptions to the Law

1. Hobbies (e.g., stamp collection):
Since every additional unit of the item collected gives the collector more pleasure, it
appears that this law does not apply in such cases. However, in reality, this is not a
genuine exception because if a stamp collector keeps collecting the same type of
stamps, his MU will fall. But collectors naturally collect a variety of the concerned
item, and so this is not a real exception because the homogeneity condition which is
needed for the law to become functional does not exist.
2. Entertainment goods (e.g., novels or movies):
Goods like music, poetry, novels, movies, etc. gives greater satisfaction with every
additional unit consumed. But, it should be noted that this exception is true only if
the homogeneity assumption is not fulfilled.
3. Habituated goods (e.g., cigarettes):
Consumers, like alcoholics, smokers or drug-addicts, derive greater pleasure as they
consume more of their habituated commodity. Thus, the law appears to fail in this
case. But this exception too can be challenged on the grounds that people consuming
habituated goods do not behave in an economically rational manner, and so the
absence of an important assumption causes the law’s tendency to fail.
4. Misers:
A miser being greedy by nature derives greater satisfaction with every additional unit
that he gathers and therefore it seems as if this law does not apply to such characters.
Here too the validity of the exception can be challenged because a miser’s behavior
is not economically rational.

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 Utility

5. Money:
It appears as if, with every increase in the amount of money that an individual
possesses, the utility that he derives from it does not diminish - i.e., with more money
a person’s happiness increases. However, the utility derived from the additional units
of money does fall - but we do not notice this decline since it occurs at a very gradual
and nearly negligible rate. For instance, a rich man would not feel the pinch if he
loses a few hundred rupees, but the same would not be the case with a poorer person.
Hence, there is an attitudinal change in the possessor towards money, as the quantum
owned changes.
Limitations
1. Cardinal measurement of utility:
Marshall’s analysis is based on a false assumption that utility can be cardinally
measured. This is not true because utility is a subjective and a psychological concept
and so non-quantifiable.
2. Unrealistic assumptions:
The conditions of homogeneity, continuity, constancy and rationality are difficult to
fulfil simultaneously in real life. Thus, the law is unrealistic.
3. Not applicable to indivisible goods:
This law does not apply to bulky and durable goods because in normal circumstances,
consumers buy only a single unit of such commodities, e.g. TVs, fridges & cars.
4. Constancy of the MU of money:
This law wrongly assumes that the MU of money is constant. In reality, we know
that money’s MU cannot be constant because it does diminish (although at a very
slow rate). However, it should be noted that the MU of money can never fall to zero
as money helps in satisfying man's unlimited wants.
5. Single Commodity Model:
The Law of DMU is a single commodity model. However, in reality, utility is
interdependent as people tend to consume complementary goods & it does not
consider the effect of complementary / substitute goods.
Importance of the Law
The Law of DMU inspite its shortcomings has theoretical as well as practical
significance.
Theoretical Significance
1) It helps in understanding the equilibrium position of a rational consumer.
2) It forms the basis for the Law of Demand, by clarifying the reasons behind the
inverse relationship between price and the quantity demanded.
3) It helps in explaining the Paradox of Value, i.e., the difference between the Value-
in-use and the Value-in-exchange of a commodity.

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Practical Significance
1) It serves as a guide to producers.
2) It helps in the formulation of appropriate tax policies.
3) It helps an individual consumer to spend his limited income rationally (through the
Law of Equi-Marginal Utility)
4) Social measures can be taken by the government through an equitable distribution
of income by means of appropriate taxation & public expenditure.

DIFFERENCES BETWEEN MARGINAL UTILITY AND PRICE

Marginal Utility Price

What
It is the additional utility derived by It is the value of a commodity expressed in
consuming one more unit of the terms of money.
commodity
Impact
It results in a gain to the consumer in the It involves a sacrifice in terms of money
form of satisfaction from consumption. given up and so there is a loss of income to
the consumer.
Determinants
It is affected by : It is affected by :
– the psychological make–up of the – the demand and supply conditions in
consumer. the economy.
– the quantity of the good consumed – the money supply in the economy
(inverse relationship). (direct relationship)
– Government policies.
inter–relationship
It determines the price level (direct It can be less than or equal to MU and never
relationship) more than MU.

RELATIONSHIP BETWEEN MARGINAL UTILITY AND PRICE

The price level which a person is willing to pay for a particular level of consumption of a
commodity is indicative of the MU that the person derives from that particular level of
consumption of the good. The greater the MU derived, the higher would be the price that
the consumer would be willing to pay and vice-versa. Given the price of a commodity, a
consumer will continue buying more of that commodity till the MU derived becomes equal
to the actual price paid. This indicates that there is a direct relationship between MU
and price.

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 Utility

Price
&
MU A
consumer’s G
surplus C Actual Price Line
D E

F B H
1 2 3 4 5 Quantity

Given the Marginal Utility curve and the price line, the consumer will be in equilibrium at
point C, where MU = Price, (i.e., he will buy 3 units). At the first unit his willing price AF
is greater than the actual price DF, which gives him a Consumer’s Surplus (DA). Due to
this surplus, he is encouraged to buy one more unit. At the second unit his willing price is
BG while the actual price is only EB and so he again earns a surplus of EG. At the third
unit of consumption, his willing price CH is the same as the actual price CH. Thus, he
reaches equilibrium at C.
Usefulness of the concept of consumer’s surplus
1. It reveals the difference between value in use & value in exchange.
2. It helps the monopolist to fix a price for his/ her commodity.
3. It helps in judging the different types of taxation.

Limitations of the concept of consumer’s surplus

1. It cannot be measured cardinally as it is difficult to measure the MUs of different
units of a commodity consumed by a person.
2. In case of necessities, the MUs of the previous units are infinitely large, in such a
case, consumers’ surplus is always infinite.
3. The Consumers’ Surplus derived from a commodity is affected by the availability
of its substitutes.
4. It cannot be measured as practically, the MU of money changes as the stock of
money with the consumer changes.

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 Utility

THE LAW OF EQUI-MARGINAL UTILITY (EMU)

Statement:
According to Marshall, ‘If a person has a thing which can be put to several uses, he will
distribute it among these uses in such a way that it has the same MU in all’.
Thus, the consumer’s TU is maximized when the MU of a Rupee’s worth of good X is
exactly equal to the MU of a Rupee’s worth of all the other goods purchased – i.e., when
the prices of goods are different, the MUs are proportional to their respective prices; hence,
TU is maximized when:
MUX MUY MUZ
= =
PX PY PZ
Assumptions:
1. MU can be measured in cardinal terms.
2. There is perfect competition in the product and factor markets.
3. The prices of the commodities are given and constant.
4. The consumer behaves in a rational manner.
5. The MU of money is constant.
6. The consumer’s income is given and constant and the consumer spends his entire
income.
7. Ceteris paribus.

Schedule:

Good X Good Y Good Z

Units MU / MU / MU /
Price MU Price MU Price MU
P P P
1 2 60 30 3 45 15 4 72 18
2 2 44 22 3 36 12 4 60 15
3 2 32 16 3 27 9 4 48 12
4 2 26 13 3 18 6 4 32 8
5 2 12 6 3 12 4 4 24 6
6 2 8 4 3 9 3 4 8 2❖
7 2 4 2❖ 3 6 2❖ 4 0 0
8 2 0 0 3 3 1 4 -4 -1
9 2 -6 -3 3 0 0 4 -8 -2
10 2 -10 -5 3 -9 -3 4 -12 -3

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 Utility

𝑀𝑈𝑋 𝑀𝑈𝑌 𝑀𝑈𝑍

Fig 1 Fig 2 Fig 3
𝑃𝑋 𝑃𝑌 𝑃𝑍
𝑀𝑈𝑍
𝑀𝑈𝑋
curve
𝑀𝑈𝑌
curve 𝑃𝑍
curve
𝑃𝑋 𝑃𝑌

6 6
6

5 QX 4 QY 5 QZ

Explanation:
In the schedule the respective prices of GX, GY and GZ are assumed to be Rs 2, Rs 3 and
Rs 4. The MU schedule of each of these goods is also given. The income of the consumer
is assumed to be Rs 42. The ratios of the MU and the price are calculated for each of the
goods at different levels of consumption. Since the Law of DMU is in operation for each
𝑀𝑈
good, the MUs reduce for every additional unit of consumption – hence, the curves are
𝑃
also downward sloping.
It will be noticed the Law of Proportionality is satisfied at 3 consumption configurations.
𝑀𝑈𝑋 𝑀𝑈𝑌 𝑀𝑈𝑍
= = = 𝐾1 = 6
𝑃𝑋 𝑃𝑌 𝑃𝑍
𝑀𝑈𝑋 𝑀𝑈𝑌 𝑀𝑈𝑍
= = = 𝐾2 = 2
𝑃𝑋 𝑃𝑌 𝑃𝑍
𝑀𝑈𝑋 𝑀𝑈𝑌 𝑀𝑈𝑍
= = = 𝐾3 = 0
𝑃𝑋 𝑃𝑌 𝑃𝑍

Combinations Total Utils Total Expenditure (Rs.)

[5X + 4Y + 5Z] {172 + 126 + 236 } = 534 (10 + 12 + 20) = 42
[7X + 7Y + 6Z] {184 + 153 + 244} = 581 (14 + 21 + 18) = 53
[8X + 9Y + 7Z] {184 + 156 + 244} = 584 (16 + 27 + 28) = 69

Now, since the consumer’s income is assumed to be Rs 42, he will have to purchase only
the first combination of the goods and derive an overall TU worth 236 utils. He will have
to forgo the greater overall TUs (of the second and third combinations) since he cannot
afford these combinations. Thus, through the Law of Equi-MU, Marshall is able to show
how a consumer spends his income over a variety of goods, with a given income and
preference schedules.

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 Utility

Fig 4 MU money

Ub Ua
G
D
F
Q

Loss

Gain
E H C R
QB 4 3 0 6 7 QA

The principle of Equi-MU can be alternatively explained as under (with the help of Fig. 4).
Along the horizontal axis, from left to right is measured the quantity of GA and from right
to left is measured the quantity of the GB. Along the vertical axis is measured the MU of
the amounts of money spent on the two goods. On the RHS of the vertical axis is drawn a
curve Ua, which is downward sloping from left to right. This curve shows the MU of
money spent on GA. On the LHS of the vertical axis is drawn the curve Ub, which sloped
downwards from right to left. This curve shows the MU of money spent on GB.
Suppose the consumer has Rs 10 to spend on the two goods. When this consumer spends
Rs 6 on GA and Rs 4 on GB, the MU of money for both the goods are equal (EF = CD). At
this combination of GA and GB, the consumer will derive maximum satisfaction. Any other
arrangement will only reduce the aggregate satisfaction. Suppose the consumer spends Re
1 more on GA, he have to consequently spend Re 1 less on GB – due to this re-adjustment,
there will be an inequality in the MUs of the two goods. Here, the gain in utility is less
than the loss in utility (GH > QR) and so the overall satisfaction will be less than before.
Hence, it can be concluded that the consumer will get maximum satisfaction and will be in
equilibrium if the Marginal Utilities of money spent on the various goods he buys are equal.
Criticisms of the Law of EMU:
1. It assumes the cardinal measurement of utility.
2. The consumers do not always behave rationally.
3. The law, by assuming that the entire income is spent, overlooks savings.
4. The consumers may not always be aware of his consumption preferences.
5. The law overlooks the indivisibility of certain goods.
6. It falsely assumes that the MU of money is constant.
Applications of the Law of EMU:
a. It helps a consumer to spread his income rationally over a variety of commodities.
b. It helps producers to decide what to produce and also the quantities to be produced.
c. It helps in the determination of prices – as scarce commodities are substituted by
abundant commodities, the price of the former falls while that of the latter rises.
d. It helps in analyzing the distribution of factor rewards.
e. It helps governments to determine its expenditure configuration vis-à-vis the
various social goods needed.
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 Utility

Value Price
what
It refers to the intrinsic usefulness of a It refers to the value of a commodity in
commodity either as value–in–use or terms of money.
value–in–exchange.
nature
Being subjective it changes from person to It is an absolute concept as it is the same
person. It is relative to time and place. for all consumers at any moment of time.
determining factors
It depends mainly on the utility and It depends on the utility, scarcity and the
scarcity of the commodity. cost of production of the commodity.

Value–in–use Value–in–exchange
what
It refers to the capacity of a commodity to It refers to the capacity of a commodity to
satisfy a human want. be exchanged for another due to the
intrinsic worth of the former commodity.
determining factors
It is determined by the utility of the It is determined by the commodity’s
commodity. exchangeability monetarily or otherwise.
relationship
The free goods like air at the sea–level or The economic commodities, viz.,
water near a perennial river have a high necessities, comforts and luxuries have a
value–in–use only. high value–in–exchange.

PARADOX OF VALUE
By this is meant that certain commodities may have a high value-in-use but its value-in-
exchange would be negligible. For instance, water near a river has a high value-in-use, but
in this area it would have no value-in-exchange (i.e., no price). This happens because the
value-in-exchange depends on both the utility and the scarcity of the commodity, while the
value-in-use would depend only on its utility. In the above example, water (near a river or
in a desert) always possesses a high utility, but near a river since it is available in plenty, it
commands no price. But, in a desert, since water is scarce it commands a price. Again,
diamonds which have a less value-in-use command a high value-in-exchange because of
its scarcity in relation to its high demand. This economic phenomenon affects the
determination of the price, production and fiscal policies.

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