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
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?
Utility can be measured in_______
Utils
Units
Kilogram
None of the Above
Ans:
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.
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 and Analysis of Utility Explained
1. What is meant by 'utility' in economics, and how is its measurement approached?
In economics, utility refers to the want-satisfying power of a commodity or service. It is the measure of satisfaction a consumer derives from consuming a good. There are two primary approaches to its measurement:
- Cardinal Utility Analysis: This approach assumes that utility is a measurable and quantifiable concept. It uses a hypothetical unit called a 'util' to measure satisfaction. For instance, one might say they get 20 utils from the first slice of pizza.
- Ordinal Utility Analysis: This approach posits that utility cannot be measured numerically but can be ranked in order of preference. A consumer can state a preference for one good over another (e.g., I prefer coffee to tea) but cannot specify by how much.
2. What are the two main types of utility analysis in consumer theory?
The two main types of utility analysis are Cardinal Utility Analysis and Ordinal Utility Analysis. Cardinal analysis, championed by economists like Alfred Marshall, suggests that satisfaction can be measured in absolute numbers. Ordinal analysis, developed by Hicks and Allen, is considered more realistic as it only requires consumers to rank their preferences without assigning a specific numerical value to their satisfaction.
3. Can you explain the Law of Diminishing Marginal Utility with a simple example?
The Law of Diminishing Marginal Utility (DMU) states that as a consumer consumes more and more units of a specific commodity, the additional satisfaction (marginal utility) derived from each successive unit keeps declining. For example, the first glass of water to a thirsty person provides immense satisfaction. The second glass offers less satisfaction than the first, and the third glass even less. Eventually, a point is reached where an additional glass of water offers zero or even negative utility.
4. What is an Indifference Curve and what are its key properties?
An Indifference Curve (IC) is a graph that shows various combinations of two goods that provide a consumer with an equal level of satisfaction. Since all points on the curve yield the same utility, the consumer is 'indifferent' to any of these combinations. Key properties of an indifference curve include:
- They are always downward sloping from left to right.
- They are convex to the origin due to the diminishing marginal rate of substitution.
- A higher indifference curve represents a higher level of satisfaction.
- Two indifference curves can never intersect each other.
5. How does the concept of diminishing marginal utility help explain why a demand curve slopes downwards?
The Law of Diminishing Marginal Utility is a fundamental reason for the downward-sloping demand curve. A consumer's willingness to pay for a commodity is based on the marginal utility they expect from it. Since the marginal utility decreases with each additional unit consumed, a rational consumer will only be willing to buy more units of a product if its price falls. Therefore, at a lower price, quantity demanded is higher, and at a higher price, quantity demanded is lower, creating the inverse relationship depicted by a downward-sloping demand curve.
6. What is the essential difference between Cardinal and Ordinal utility analysis?
The essential difference lies in the measurability of utility. Cardinal Utility analysis assumes that utility is quantifiable and can be expressed in absolute units (utils), allowing for statements like "Product A gives me twice the satisfaction of Product B." In contrast, Ordinal Utility analysis assumes that utility is not quantifiable but is comparable. It allows for ranking preferences, enabling a consumer to say, "I prefer Product A to Product B," but not by how much. Ordinal analysis is widely considered a more practical and realistic approach to consumer behaviour.
7. What does 'consumer's equilibrium' signify in the context of utility analysis?
Consumer's equilibrium refers to a situation where a consumer achieves maximum satisfaction from their limited income and has no tendency to change their existing pattern of consumption. In cardinal analysis, this is typically achieved when the ratio of marginal utility to the price is the same for all goods consumed, and this ratio equals the marginal utility of money (MUx/Px = MUy/Py = ... = MUm). In ordinal analysis, equilibrium is reached when the budget line is tangent to the highest possible indifference curve.
8. Why is the concept of 'utils' in Cardinal analysis considered a major limitation?
The concept of 'utils' is a major limitation because satisfaction is inherently subjective and psychological. It cannot be measured with an objective, standardized unit like length (metres) or weight (kilograms). The level of satisfaction derived from a good varies greatly from person to person, and even for the same person, it can change with time and circumstances. This lack of a concrete, universal unit of measurement makes the core assumption of Cardinal Utility analysis unrealistic for real-world applications.
9. What is the Law of Equi-Marginal Utility and where is it applied in real life?
The Law of Equi-Marginal Utility, also known as the law of substitution, states that a consumer will distribute their limited income among various goods in such a way that the marginal utility derived from the last unit of money spent on each good is equal. Essentially, a consumer substitutes a good with higher marginal utility for one with lower marginal utility until this balance is achieved. This principle is widely applied in:
- Consumption: By individuals to maximise their total satisfaction from a given budget.
- Production: By producers to allocate resources among different factors of production to maximise output.
- Public Finance: By governments to allocate revenue across different public welfare projects to maximise social benefit.
