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Concept of Utility What does Utility Mean? Approaches to the theory of consumer behavior to demand Cardinal Utility Ordinal Utility Difference between Cardinal & Ordinal Utility Aspects of Utility Relationship between Total Utility and Marginal Utility Explained by Table & Diagram Law of Diminishing Marginal Utility Basis of Law of Diminishing Marginal Utility Law based upon three facts Law of Diminishing Marginal Utility Explanation by Table And Diagram Assumptions of Law of Diminishing Marginal Utility Limitations of law of diminishing marginal utility References

Jevon (1835-1882) was the first economist who introduces the concept of utility in economics.

 An economic term referring to the total satisfaction received from consuming a good or service. In economics the satisfaction or pleasure consumers derive from the consumption of consumer goods is called utility. Consumers, however, cannot have every thing they wish to have.

 Consumers choices are constrained by their incomes. Within the limits of their incomes, consumers make their consumption choices by evaluating and comparing consumer goods with regard to their utilities.

There are two main approaches to the theory of consumer behavior to demand.
The first approach is the Marginal Utility or Cardinalist Approach. The second is the ordinalist Approach.

The concept of Cardinal Utility was used by Marshal to define Consumer's Equilibrium. Cardinal Utility means consumer could measure the satisfaction derived by the consumption of any goods or services in terms of number and unit of that measurement is Utils or the Money.

Ordinal Utility means giving the rank to the utility derived by the consumption of goods and services. This Concept was given by Slustsky, a Russian economist in 1915.Later on it was developed by J.R. Hicks & R.G.D.Allen in the year 1928. This is more realistic and better than cardinal utility. This is totally based on Introspection.

Cardinal utility:

satisfaction levels that can be measured or specified with numbers (units = utils) whereas

Ordinal utility:

satisfaction levels that can be ordered or ranked

Initial Utility Total Utility Marginal Utility Positive Utility Zero Utility Negative Utility

Utility of the first unit of a commodity consumed is known as Initial Utility.

Utility which is attained from the use of a specific number of the units of a commodity is called total utility. Total utility is equal to the sum of separate utility which is attained from every unit.

For Example If a man eats two apples while the utility of first apple is 6 and 4 of the second. Then total utility will be 6+4=10

Utility of the last unit of a commodity consumed or utility of an additional unit consumed is called marginal utility. Separate utility of every unit is called marginal utility. Mu =TU /Q

As long as total utility keeps on increasing and marginal utility is not zero, then utility is positive.

When desire of a good is fully satisfied and consumer has no desire to consume further unit then utility is Zero. This will be consumers point of satiety.

When utility of a good is zero but consumer consumes further units of it, then utility becomes negative. Total utility decreases in case of negative utility.

 When Marginal Utility is Positive, Total Utility (increases).

When Marginal utility is zero, Total Utility is maximum. When Marginal Utility is negative, Total Utility (Decreases)

Total utility = Sum of marginal utilities

Units of apples Consumed daily 1 2 3 4 5 6

Total utility 7 11 13 14 14 13

Marginal Utility 7 4 2 1 0 -1

The above table shows that when a person consumes no apples, he gets no satisfaction. His total utility is zero .in case he consumes one apple a day, he gains seven utils of satisfaction. His total utility is 7 and his marginal utility is also 7. In case he consumes second apple, he gains an extra 4 utils (mu). Thus giving him a total utility of 11 utils from two apples. His marginal utility has gone down from 7 utils to 4 utils because he has a less craving for the second apple.

Same is the case with the consumption of third apple. The marginal utility has now fallen to 2 utils while the total utility of three apples has increased to 13 utils (7+4+2). In case the consumer takes fifth apple, his marginal utility falls to zero utils and if he consumes sixth apple also, the marginal utility is reduced to negative (13-14=-1). It is -1 utils. The table showing total utility and marginal utility is plotted in figure below:

 The total utility curve starts at the origin as zero consumption of apples yields zero utility. The TU curve reaches at its maximum or a peak of M when MU is zero The MU curve falls throughout the graph. A special point occurs when the consumer consumes 5th apple. He gains no marginal utility from it. After this point, marginal utility becomes negative.

 The MU curve can be derived from the total utility curve. It is the slope of the line joining two adjacent quantities on the curve. For example, the marginal utility of the third apple is the slope of line joining points a and b. the slope of such a line is given by the formula.
MU = TU Q

The law of diminishing marginal utility describes a familiar and fundamental tendency of human behaviour.The law of diminishing marginal utility states that, as a consumer more and more units of a commodity, the utility from the successive units goes on diminishing

Mr. H.Gossen, a German economist, was the first to explain this in 1854. Alfred Marshal later on restated this law in the following words; The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that he already has.

Basis of this Law is a fundamental feature of wants. It states that when people go to the market for the purchase of commodities, they do not attach equal importance to all the commodities which they buy. In case of some of commodities, they are willing to pay more and more in some less.

There are two main reasons for this difference in demand. The liking of the consumer for the commodity The quantity of the commodity which the consumer has with himself. The more one has of a thing, the less he wants the additional units of it. In other words, the additional utility of a commodity diminishes as the consumer gets larger quantities of it.

The law of diminishing utility is based upon three facts. First, total wants of a man are unlimited but each single want can be satisfied. As a man gets more and more units of a commodity, the desire of his want for that good goes on falling. A point is reached when the consumer no longer wants any more units of that good.

Secondly, different goods are not perfect substitutes for each other in the satisfaction of various particular wants. As such the marginal utility will decline as the consumer gets additional units of a specific good.

Thirdly, there is no change In the tastes of the consumers.

 If Im really hungry, I get a lot of satisfaction from first slice of pizza. If I keep eating pizza, the satisfaction from the 8th slice would be much less than that of the first slice.

Time period must be specified for law.

According to this table, the more glass of water the consumer consumes, the less marginal utility becomes. At 4th glass of water, marginal utility becomes zero.

It is satiety point because now the desire of consumer for glass of water is satisfied and marginal utility becomes zero, after consumes more glass of water, as on 5th and 6th glass of water, marginal utility becomes negative -2 and -4 respectively.

In this diagram, glass of water on OX curve and marginal utility on OY curve are shown. MU is marginal utility curve. This curve moves from left to right downwards. The tendency from left to right shows increase in the number of glass of water and to move downwards tendency shows the fall in marginal utility.

The law of diminishing marginal utility is true under certain assumptions. These assumptions are as under:

(I) Rationality
In the cardinal utility analysis, it is assumed that the consumer is rational. He aims at maximization of utility subject to availability of his income.

(ii) Constant marginal utility of money

It is assumed in the theory that the marginal utility of money based for purchasing goods remains constant. If the marginal utility of money changes with the increase or decrease in income, it then cannot yield correct measurement of the marginal utility of the good.

(iii) Diminishing marginal utility

Another important assumption of utility analysis is that the utility gained from the successive units of a commodity diminishes in a given time period.

(iv) Utility is additive

In the early versions of the theory of consumer behavior, it was assumed that the utilities of different commodities are independent. The total utility of each commodity is additive.
U = U1 (X1) + U2 (X2) + U3 (X3). Un (Xn)

(v) Consumption to be continuous

It is assumed in this law that the consumption of a commodity should be continuous. If there is interval between the consumption of the same units of the commodity, the law may not hold good. For instance, if you take one glass of water in the morning and the 2nd at noon, the marginal utility of the 2nd glass of water may increase.

(vi) Suitable quantity

It is also assumed that the commodity consumed is taken in suitable and reasonable units. If the units are too small, then the marginal utility instead of falling may increase up to a few units.

(vii) Character of the consumer does not change

The law holds true if there is no change in the character of the consumer. For example, if a consumer develops a taste for wine, the additional units of wine may increase the marginal utility to a drunkard.

(viii) No change to fashion

Customs and tastes: If there is a sudden change in fashion or customs or taste of a consumer, it can than make the law inoperative.

(ix) No change in the price of the commodity:

There should be any change in the price of that commodity as more units are consumed.

 Knowledge
This law does not apply on the acquisition of knowledge. If a person acquires more and more knowledge, his desire for knowledge increases instead of decreasing. However, about study we can say that a person gets bore at a certain stage. In other words, its marginal utility becomes zero.

 Wealth and money

The desire of collecting wealth and money increases instead of decreasing. If a person earns more and more wealth, his desire for increasing it rises higher and higher. So, this law does not apply on wealth and money. However, if we consider the consumption of money, it becomes clear that a rich man spends money extravagantly as compared to a poor man. It clearly shows that increase in wealth causes a fall in its utility.

 Historical articles
Desire to get historical articles never decreases. For example, old coins and stamps collecting is the hobby of some apple. They wish to have more and more coins and stamps. So, this law does not apply on historical articles also.

 Personal show-off
Naturally, some people have self-assertion or they want to show off themselves. The desire for getting or purchasing cosmetics or fashionarticles also increases instead of decreasing. So, commodities of personal show off are also included in exceptions of this law.

 Drugs and narcotics

This law can also not be applied on drugs or narcotics e.g., opium, heroine etc. because the more a person uses drugs, the greater urge he feels for them.

References

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=utility+measurement
http://welkerswikinomics.wetpaint.com/page/Law+of+Diminishing+Marginal+Utility http://faculty.lebow.drexel.edu/McCainR//top/Prin/txt/MUch/Eco416.html http://www.economicsconcepts.com/law_diminishing_marginal_utility.htm http://wiki.answers.com/Q/What_is_the_difference_between_cardinal_utility_and_ordinal_utility#ixzz1Oquna4OX http://en. wikipedia.org/wiki/Utility http://searchcio-midmarket.techtarget.com/definition/utility http://wiki.answers.com/Q/What_is_the_difference_between_cardinal_utility_and_ordinal_utility http://en.wikipedia.org/wiki/Utility http://www.investopedia.com/university/microeconomics/microeconomics2.asp

http://www.scribd.com/doc/51632996/part2-utility-ppt http://www.oup.com/uk/orc/bin/9780199285006/fulcherandscott_ch07.pdf http://www.investopedia.com/terms/u/utility.asp http://www.economicsconcepts.com/cardinal_utility_analysis.htm http://en.wikipedia.org/wiki/Utility#Cardinal_and_ordinal_utility http://hope.dukejournals.org/cgi/pdf_extract/21/2/351 http://www.ppt2txt.com/r/2df1586d/