This document provides an introduction to utility analysis, including definitions and key concepts. It defines utility as the satisfaction derived from consuming a good. Consumers demand goods that provide utility. There are three main theories of utility: cardinal, ordinal, and revealed preference. Cardinal utility analysis holds that utility can be measured in definite numbers. Total utility is the aggregate satisfaction from consuming a good, while marginal utility is the change in total utility from an additional unit. Total utility increases at a diminishing rate as marginal utility decreases but remains positive, until total utility reaches a maximum and marginal utility becomes zero. The relationship between total and marginal utility helps explain phenomena like the diamond-water paradox and consumer surplus.
This document provides an introduction to utility analysis, including definitions and key concepts. It defines utility as the satisfaction derived from consuming a good. Consumers demand goods that provide utility. There are three main theories of utility: cardinal, ordinal, and revealed preference. Cardinal utility analysis holds that utility can be measured in definite numbers. Total utility is the aggregate satisfaction from consuming a good, while marginal utility is the change in total utility from an additional unit. Total utility increases at a diminishing rate as marginal utility decreases but remains positive, until total utility reaches a maximum and marginal utility becomes zero. The relationship between total and marginal utility helps explain phenomena like the diamond-water paradox and consumer surplus.
This document provides an introduction to utility analysis, including definitions and key concepts. It defines utility as the satisfaction derived from consuming a good. Consumers demand goods that provide utility. There are three main theories of utility: cardinal, ordinal, and revealed preference. Cardinal utility analysis holds that utility can be measured in definite numbers. Total utility is the aggregate satisfaction from consuming a good, while marginal utility is the change in total utility from an additional unit. Total utility increases at a diminishing rate as marginal utility decreases but remains positive, until total utility reaches a maximum and marginal utility becomes zero. The relationship between total and marginal utility helps explain phenomena like the diamond-water paradox and consumer surplus.
This document provides an introduction to utility analysis, including definitions and key concepts. It defines utility as the satisfaction derived from consuming a good. Consumers demand goods that provide utility. There are three main theories of utility: cardinal, ordinal, and revealed preference. Cardinal utility analysis holds that utility can be measured in definite numbers. Total utility is the aggregate satisfaction from consuming a good, while marginal utility is the change in total utility from an additional unit. Total utility increases at a diminishing rate as marginal utility decreases but remains positive, until total utility reaches a maximum and marginal utility becomes zero. The relationship between total and marginal utility helps explain phenomena like the diamond-water paradox and consumer surplus.
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Lecture-4
Introduction to Utility Analysis
Learning Objective: Utility, features of utility, measurements and relationship between total and marginal utility Utility: The property of the commodity that enables it to satisfy a want is termed as utility. It is known as want satisfying power of the commodity. The units of measurement of utility are called utils. Or Utility is the satisfaction, actual or expected, derived from the consumption of a good. Normally it is the expected satisfaction, because we generally purchase first and consume later. Why does a consumer demand a good /service? The simple answer is that he/she demands a good as it gives him/her utility. Secondly how he/she should spend his/her income on different goods and services so as to maximize his/her satisfaction. In economics three main theories have been put forward in this regard. 1.
Cardinal utility analysis
2.
Ordinal utility analysis
3.
Revealed preference analysis
Cardinal utility analysis: Neoclassical economist like Dupit, Gossen, Walaras ,Menger and Jevous put this analysis by criticizing the classical thought of Adam Smith, Ricardo and others. According to this approach, utility can be measured in cardinal or definite numbers like 1, 2, 3, etc. Cardinal numbers are those definite numbers which can be added or subtracted.
Fisher has used the term Util as a measure of utility. For example according to this approach, it can be said that consumption of one apple will give say 5utils and so on. Features of utility: Utility is a subjective because it deals with the mental satisfaction of human beings. A thing may have different utility for different persons. Utility is relative. Utility of a good never remains the same. It varies across time and place. For example, Warm clothes have utility in winters not in summers. Utility is not essentially useful. A commodity having utility need not be useful. For example cigarettes are not useful however they satisfy the wants of those who smoke. Utility is independent of morality. Utility has nothing to do with morality. Use of liquor may be immoral but it has utility those use it. Types of utility: Marginal utility: Marginal utility (MU) means change in the total utility (TU) derived from the consumption of one more unit of a good i.e. the additional or extra utility received from consuming each additional unit of a commodity is called marginal utility Mathematically it is calculated as: MUn
TUn TUn-1
Total utility; - Total Utility (TU) is the aggregate of the utility that a consumer derives from the consumption of a certain amount of a commodity. Mathematically, TU can be obtained by the sum of marginal utilities from the consumption of different units of the commodity. TUn
= =
MU1 + MU2 + + MUn
MU
Measurement of utility:There are two viewpoints regarding the measurement of utility.
1. Cardinal utility analysis:-It means that the utility that a consumer gets from a unit of commodity can be measured in absolute numbers. eg : 1, 2, 3, 4 .
2. Ordinal utility analysis: - It states that the consumer is capable of simply
comparing the utility derived from different goods or different units of the same good. It means utility cannot be measured. It can only be compared such as 1 st, 2nd, 3rd, 4the etc Relationship between Total utility and Marginal utility No. of Units Consumed 1 2 3 4 5 6 7
Total Utility 25 45 60 70 75 75 70
Marginal Utility 25 20 15 10 5 0 -5
When TU increases at diminishing rate MU falls but remains positive
When TU becomes maximum & constant MU becomes zero. When TU declines MU is negative
Significance of the Difference between Total and Marginal Utility:
The difference between total and marginal utility has the following practical significance.
Paradox of value or the diamond water paradox: Many economists assumed
that the price of the commodity was equal to the total utility. Thus goods which give more total utility should have more value and which have less total utility should have less value. But it is not true in the real life situations. One obtains more total utility from water than from diamonds, yet the price of water is less than diamonds. This is known as Diamond- water paradox. Price of the commodity is determined by the marginal utility and not the total utility. Water is available in abundance, so its total utility reaches the saturation point i.e. marginal utility becomes zero. Consequently, although the total utility derived from water is exceedingly large because of the great quantity consumed, yet its marginal utility is very low; so price of water is almost zero. On the other hand, availability of diamonds is very rare, so their total utility never
reaches the point of saturation. Consequently, although the total utility derived from diamond is low because consumers purchase relatively few of them, yet marginal utility of diamonds remains high and positive. That is why price of diamonds is high. Consumer Surplus: Sometimes a consumer is ready and willing to pay for a commodity much more price than its actual price. The difference between the two prices is called consumer surplus. The consumer is prepared to pay the price equivalent to the total utility that he obtains from all the units of the commodity but actually he pays the price equivalent to the marginal utility of the commodity. Marginal unit refers to the additional unit that the consumer is prepared to buy. Each unit preceding the marginal unit (called intra- marginal units) would give the consumer more utility than the utility of the marginal unit. Aggregate of the marginal utilities of these units is called total utility. But the price being equal to the marginal utility, the amount of money actually paid by the consumer will be equivalent to the marginal utility (price) multiplied by the number of units bought. The concept of consumer surplus is thus based on the difference between total utility and marginal utility. Questions
1 When total utility is increasing at an increasing rate, marginal utility is
a) Constant b) Increasing c) Decreasing i.
Zero
2 The concept of consumer surplus helps a monopolist firm:
a) To levy high prices b) To levy low prices c) To choose prices under Govt directives d) All of the above 3Marginal utility signifies a) utility from first unit b) utility from last unit c) utility from additional unit d) None of above 4The want satisfying power of a commodity is called a) Demand b) Utility c) Consumption d) Production 5 According to Marshal Utility a) Can be measured b) Cannot be measured c) Can be measured via money d) None of the above Answers 1b) 2c) 3 b) 4b) 5 c)
