Courses
Courses for Kids
Free study material
Free LIVE classes
More

# Measurement of Utility and Its Analysis

## Concept of Utility

Utility refers to the quality of goods that can meet our needs. Utility depends on the mental judgement of the consumer and is determined by several factors that influence consumer judgement. These factors include, for example, the intensity of the desire to be satisfied, and it satisfies different consumers in different ways, depending on their preferences. For example, enjoying a cup of coffee may benefit person A more than person B because a particular desire may be felt to varying degrees by different consumers.

## Types of Utility

The utility can be classified as follows:

• Total utility refers to the sum of the utilities obtained by consuming all units of the commodity.

• Average Utility is derived by dividing the total utility obtained by a consumer by the number of units of X commodity consumed.

• Marginal Utility refers to the additional utility resulting from the consumption of additional units of a commodity.

## Law of Diminishing Marginal Utility

The law of diminishing marginal utility is the foundation stone of utility analysis. It means that the value of a good, the extra utility derived from the good, declines as more of the good is consumed. If satisfaction is obtained from a good decline, then buyers are willing to pay a lower price. Hence, demand price is inversely related to the quantity demanded which is the law of demand. It is based on certain assumptions.

• All the units of the commodity are completely homogeneous.

• Utility is a psychological concept, and it varies from person to person.

• The consumer is a rational human being, and he strives for maximum satisfaction.

Law of Diminishing Marginal Utility

## Measurement of Utility

To understand the concepts and the measurement of utility further, we need to discuss two economic approaches in relation to utility, i.e., cardinal utility and ordinal utility.

• Cardinal Utility Approach - Let's start with understanding the Cardinal utility meaning. The cardinal utility concept was introduced by neo-classical economists. It was believed that utility can be measured. Cardinal utility can be described as the utility expressed in fixed units. It is measured in cordial numbers 10, 20, 30 etc. Marshall used an imaginary unit called utils to measure the utility. The Cardinal utility approach is also referred to as utility analysis.

• Ordinal Utility Approach - Ordinal approach was proposed by J.R Hicks and Allen. When utility is expressed in ranks like more utility or less utility, it is called ordinal utility, but it is often said that utility is a psychological concept and cannot be measured. For example, a person prefers milk over coffee, so he or she can indicate his/her preferences by ranking them in order of their liking. The ordinal utility is also called indifference curve analysis.

## Case Study

1. If the price of tea and coffee is Rs 40 and Rs 30, respectively, and the marginal utility of coffee is 150, what is the marginal utility of tea, assuming that the consumer is at equilibrium?

2. Utility can be measured in_______

1. Utils

2. Units

3. Kilogram

4. None of the Above

Ans:

1. A consumer attains equilibrium when marginal utilities of both the goods are equal, or the utility from the rupee spent on goods is also equal, assuming equality of price of each good. Condition for consumer equilibrium in two commodity cases:

The marginal utility of good 1 is equal to the marginal utility of good 2.

MUx/Px = MUy/Py

MUx/40=150/30

MUx = 150/30 x 40

MUx = 200

So, the marginal utility of tea is 200, assuming that the consumer is at equilibrium.

1. The Correct option is I.

The utility can be measured in terms of utils. There was no standard unit of measuring utility that a person derives from the consumption of goods and services. Utilities can be classified as imaginary units which become the basis to measure a person's satisfaction in terms of utility from the consumption of a commodity.

## Summary

It is important to know the meaning of utility and its measurement approaches as it helps us in understanding the demand behaviour of individual consumers and, by extension, the demand behaviour of the market as a whole. The basis of reasoning is that a consumer compares the utility of goods with the price they have to pay for it and purchases the same commodity again so long as the utility from them is at least equal to the price to be paid for them.

## FAQs on Measurement of Utility and Its Analysis

1. What is consumer’s equilibrium?

Consumers are in equilibrium when they buy combinations of products that do not tend to rearrange their product purchases. It follows certain assumptions:

• Consumers have a default promiscuous map that represents a scale of preference for various combinations of A and B. He has a certain amount of money that he spends on two goods and given the income he has to spend on two goods.

• The prices of the two commodities are given and are constant for him.

2. What is equi-marginal utility?

According to the law of equi-marginal utility, a rational individual does not spend his entire income on one commodity. The consumer knows that if he purchases more units of the same commodity, then the marginal utility of each successive unit would decline.

Hence, to get the maximum utility from his limited income, he spends his limited income in such a way that the last unit of money spent on different commodities yields equal marginal utility. It is assumed that the consumer decides to divide his total expenditure between different goods by taking into consideration not only their respective marginal utilities but also per unit cost.

3. What is the Indifference curve?

Indifference curves provide an analysis of consumer behaviour and attempt to eliminate the shortcomings of cardinal utility analysis. It is the place of various combinations of two products that give the consumer the same satisfaction. The consumer is indifferent because all products on the indifference curve give the consumer the same satisfaction. Alternatively, the consumer is indifferent to the various combinations found on the indifference curve. Each combination provides the same level of satisfaction, so the overall satisfaction or utility derived from each of these combinations remains constant.

Comment