Ek taa Utkarsha Classes

Utility.
The term Utility is defined as the capacity of a commodity or service to fulfill a human want. In other words is means want satisfying power of a commodity The capacity of a good to satisfy a human want is known as Utility. Characteristics of Utility. 1. 2. Utility is morally colourless concept : it does not distinguish between good or bad. For e.g. cigarette smoking gives utility to a habitual smoker. But it is bad for health. Utility is different from usefulness : Utility is the want satisfying power of a good, while usefulness is the benefit which the consumer gets. A commodity may have utility but may not be useful. Poison has utility to a person who wants to commit suicide , but it serves no useful purpose. Utility is different from satisfaction: Utility is the quality possessed by the commodity before its consumption. Satisfaction is derived after the consumption of the good. Utility is what a commodity possesses whereas satisfaction is what a commodity gives. Utility is mental assessment while satisfaction is actual realisation. Utility is the means and satisfaction is the end. Utility is different form pleasure : Some goods do not give pleasure but they have utility and hence they are demanded. E.g. bitter medicines have utility because they satisfy our wants but do not give pleasure. Utility is a subjective concept : Utility relates to the consumers mental attitude and experience regarding a given commodity . so the utility of a commodity differs from person to person. For instance, cigarettes have no utility to a non-smoker. Utility is relative in nature : Utility is relative to time, place to person. It differs from person to person, place to place and time to time. Umbrellas have greater utility in rainy season. Woolen clothes have more utility in cold places. Utility is multi-purpose : The same commodity can have the capacity to satisfy different wants. E.g. Coal can be used for cooking or for a factory or for a railway engine. Utility is not measurable : since utility is subjective concept, accurate mathematical calculation is not possible. However marshal introduced the approach for cardinal measurement. The extent of utility of anything depends upon the intensity of its wants. For e.g. a glass of water gives maximum utility to a thirsty person.

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Types of utility : 1. 2. Form utility : Utility of a commodity can be increased by changing the form of the existing matter, e.g. when wood is converted into chair form utility is added. Place utility : By transferring a good from one place to another, utility can be added. When cotton is transported from Bombay to Ahmedabad, place utility is created. Transported services create place utility.

3. Service utility : Direct personal services rendered by doctors, teachers etc, to the people is known as service utility. 4. Time utility : When utility of a commodity is increased with a change of time is known as time utility. E.g. Storing food grains after harvest and bringing them in the market at times of scarcity, increases there utility.

Total utility and Marginal utility Total utility is the sum total of all the utilities derive by a consumer from all the possible units of a commodity. Marginal utility is the addition made to the total utility by the consumption of one more or an additional unit of a commodity. Total utility Total utility is the total sum of all the utilities from all the units of a commodity consumed by a person. Marginal utility Marginal utility is the addition to total utility by consuming one more unit of the commodity.

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Initially total utility increases at a diminishing rate. After a point, total utility becomes constant and maximum. This is the saturation point After the saturation point total utility starts declining. Total utility shows value in use of a commodity. Marginal utility starts decreasing from the second unit of consumption. At this point marginal utility is zero. From the point marginal utility become negative. Marginal utility shows its value in exchange.

Relation ship between total utility and Marginal utility. Suppose the consumer consumes units of a commodity, say mangoes. We assume that (1) The mongoes are identical. (2) They are consumed in quick succession. (3) Utility can be measured in cardinal numbers. TOTAL UTILITY AND MARGINAL UTILITY SCHEDULE. SCHEDULE Units of Commodity 1 2 3 4 5 6 7 Total 10 18 24 28 30 30 26 Utility Marginal 10 8 6 4 2 0 -4

Utility is measured on the Y-axis and units of commodity on the X-axis (1) As the consumer goes on consuming units of a commodity, the Total Utility goes on increasing at the beginning but at a diminishing rate. The Marginal Utility goes on falling right from the beginning. When M.U. is positive, T.U increases but at diminishing rate. The TU curve slopes upwards indicating that T.U increases at the rate of MU. Marginal utility curve slopes downwards from left to right showing that MU falls with every successive unit consumed. (2) If the consumer keeps on consuming more units of mangoes, a stage is reached when TU remains constant i.e. the additional unit does not give him, any extra satisfaction and hence MU become zero. When TU is maximum and constant MU is zero. In our illustration the consumer would consume 6 units by paying a price as he gets the maximum TU at this point. When MU curve intersects the X-axis the TU is at the peak. (3) If the consumer still consumes more units of mangoes, the he will experience dissatisfaction or disutility and his TU begins to decline. MU becomes negative. If the aim of the consumer is to maximize his satisfaction, then he will stop his consumption when MU is zero. If he consumes the 7th unit he will experience negative marginal utility. The consumer gets disutility and TU falls hence he will not consume the 7th unit even if it is available freely. When MU curve becomes negative TU curve starts falling. The law of Diminishing marginal utility Utility is a basic concept involved in the analysis of demand or consumer behaviour. It refers to the want satisfying power or capacity of a commodity to satisfy human want. Professor Marshall assumed cardinal measurement of utility. He introduced the concepts of total and marginal utility in the numerical measurement of utility. Total utility : It refers to the total satisfaction experienced or obtained by a consumer from all the units of a commodity consumed. Thus, generally total utility tends to be more with a larger stock and less with a smaller stock. Marginal utility : It refers to the successive increament in total utility made by taking seperately each unit of a commodity. It is the net addition to total utility after consuming each unit . Thus MU (n) = TU (n) TU (n-1) The law expresses the mode of consumers satisfaction of commodity. It is our common experience that as we go on having more and more units of a commodity, every additional unit which he consumes gives less satisfaction.

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Statement of the law : Given by Marshall 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 Thus briefly others things being the equal with the increase in stock of a commodity consumed or acquired it marginal utility diminishes Thus in other words each additional unit of consumption adds relatively less and less to the total satisfaction derived Illustration of the law SCHEDULE Units of Commodity 1 2 3 4 5 6 7 Total 10 18 24 28 30 30 26

Utility Marginal 10 8 6 4 2 0 -4

Thus from the utility analysis, it appears that as unit of a commodity consumed increases the marginal utility from every additional unit diminishes. Zero marginal utility implies point of satiety . later the MU becomes negative indicating disutility and dissatisfaction from excessive consumption . Total utility increases upto a certain level and then start diminishing when total utility diminishes instead of satisfaction, feelings of dissatisfaction arises. Relation between TU and MU 1. At first unit TU= MU 2. TU increases upto consumption of few units, but MU always diminishes but it is positive. 3. When TU is maximum , MU is zero. 4. When TU decreases , MU is negative. Explanation : Every additional unit of the commodity consumed give lesser and lesser MU to the consumer more the commodity , lesser the desire to have it. Hence MU curve is downward sloping and indicates inverse relationship between stock of a commodity and MU. When MU curve touches the X axis MU becomes zero and at this point of satiety consumption shall stop. If the consumer still consumes more units, instead of satisfaction there is dissatisfaction. Assumptions : The law is based on some assumptions i.e. it is proved only the following conditions hold true. 1. Homogeneity : All the units consumed must be homogeneous in nature. ( it means all the units consumed must be of same size, colour, taste etc.) It is likely that MU may tend to increase rather than diminish with the successive additional unit. 2. Continuity : Units are taken one after another without any interval of time. 3. Reasonability : the Units of consumption are in reasonable size, shape or normal standard unit. E.g. a glass of milk, a cup of tea etc. 4. Constancy : There should be no change in income, taste, habit or preference of the consumer. Similarly the price of commodity is also assumed to be given. 5. Rationality condition : The consumer is assumed to be rational economic person. His behaviour is normal and his object is to maximise satisfaction. 6. Constancy of MU of money : Through out the operation of law, it is assumed that not only money income of consumer is given but its MU remains constant. This is required to keep consumers preferences unchanged. 7. Cardinal measurement of utility : it is assumed that utility can be numerically measured and is express by the consumers objectively in utility. Exception of the law The law is deemed to be universal. However it has been observed that a consumer tends to attain increasing MU with increase in the stock of commodity. Such cases are treated as an exception to the law of DMU. But really speaking, these so called exceptions are not very genuine cases and are invalid when we strictly apply the assumptions of the law. 1. 2. Hobbies : It is often argued that in certain hobbies like stamp collection etc every additional unit gives more pleasure i.e. MU tends to increase. This is true , but it not a genuine exception because in such case homogeneity condition is violated. Drunkard : A drunkard receives more pleasure with every successive dose of liquor. But here the rationality law is violated.

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Misers : greed increases with every additional acquisition of money. So MU of money does not diminish for him with more money. But when he spends his money, utility of commodity will diminish more rapidly then in case of others. Music and poetry : A repeat hearing gives a better satisfaction. But there is a limit as several hearings of the same music or poetry proves to be monotonous(boaring) and yields disutility. Reading : since more reading gives more knowledge would give more and more satisfaction from every additional book. Here but the homogeneity law is violated. Money : with the increase in money purchasing power increases, so its utility increases. But it is not true. Money in fact is subject to the law , as its MU diminishes. It is our experience that lower the income greater is the MU of money. But higher the income. Lower is the MU of money. Also MU of money diminishes, but very slowly depending on the income of a person psychological attitude, spending habits etc.

The law even though criticized has a lot of theoretical and practical importance. If form the basis of price and demand analysis. Criticism of the law of Diminishing Marginal Utility. 1. Cardinal Measurement : the law assumes that utility can be measured in cardinal numbers . But utility is a subjective phenomena . It is a sense of feeling which cannot be expressed numerically. But it can be measured ordinally i.e. the order of utility whether it is higher or lower can be determined. 2. Unrealistic Assumptions: The law is based on unrealistic assumptions. The homogeneity , continuity, constancy and rationality conditions all together at a time are very difficult to be found in practice. 3. Inapplicability to indivisible Goods : the law cannot be applied to indivisible bulky goods like T.V. refrigerator because normally the consumer would buy only one unit of such good. 4. Marginal Utility of Money : The assumption that the marginal utility remains constant is unrealistic, Actual experience shows that marginal utility of money does diminish. 5. Substitution and Complementary is Ignored : Utility that a person derives from a commodity depends not only on the stock he has but also upon the stock that other have. The law neglects the relationship of substitution and complementary between different commodities. 6. Concept of Utility is Vague : The concept of utility may not be useful to measure the behaviour of the Consumer. People may buy goods not only because of their want satisfying capacity but also because of habit, or to imitate other or to show off . The concept of utility is vague and indefinite. 7. The law considers only one commodity but in actual life our consumption consists of numerous commodities. IMPORTANCE OF THE LAW The law of Diminishing marginal utility has theoretical and practical significance. {A} Theoretical Significance : 1. Consumer Behaviour : The law explains the behaviour of a rational consumer in respect of a single commodity and how he attains equilibrium by equating its price and marginal utility. 2. Universal Truth : The law states that a single want taken at a time is fully satiable and that diminishing marginal utility is universally applicable. 3. Paradox of Value : The law explains the paradox of value by showing the divergence between value-in- exchange. 4. Source for Other Economic Laws : The law forms the basis of some important economic concepts and laws such as law of Equi-Marginal utility, law of demand, concept of elasticity of demand, concept of consumers surplus etc. {B} Practical significance 1. Helpful to Producers : the law guides the producer to promote sales by reducing the price. When the price falls, The consumer buys more in order to reduce his marginal utility to that extent. 2. Helpful to consumers : (house expenditure) A consumer will buy a commodity only as long as the marginal utility is equal to the price. The balance of his earnings is used to buy other things. Thus the consumer can plan his expenditure according to the marginal utility he gets and avoid wasteful expenditure. 3. Public finance : The law of diminishing marginal utility has great significance in the field of public finance as it is useful for the finance minister to frame taxation policies. The marginal utility of money is more to the poor and less to rich, So progressive taxes are justified on the ground that the ability of the rich to pay taxes is much higher than that of the poor. 4. Welfare Policy : On the basis of this law, the government can tax the rich heavily and transfer the money to the poor in the form of social expenditure like unemployment benefits, free education, medical aid etc. This will lead to equitable distribution of wealth and the

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economic welfare of the poor will increase. The law is useful to the socialists to promote redistribution of wealth, social justice and social welfare. 5. Determination of Prices and levels of Demand and Supply : Higher the estimate of marginal utility, greater the demand and higher will be the price the consumer is ready to pay and vice versa. When supply increases marginal utility falls. So the seller will have to reduce the price if they want to sell more. Thus the concept of marginal utility is important in determining the prices of commodities. 6. Price Discrimination : The law useful to the monopolist in practicing price discrimination. To maximise his profits, a monopolist may charge a higher price from the rich and lower price from the poor for the marginal utility of money is less to rich and more to the poor. Marginal utility and Money : Money is one such thing. Where the more one has, the more he wants. But even in the case of money marginal utility diminishes. E.g. suppose A gets a daily income of Rs. 100/- and B gets Rs. 10/- Suppose the employer decides to give Rs 2/- to both. A is not bothered much, but B welcomes it. Similarly , if both are asked to part with Rs 2/- A gives readily, but B is reluctant. This shows that more and more of money one has the less is the marginal utility of additional unit of money. Thus the law is applicable to money too for the Marginal utility of money is more to a poor man than to a rich man. Progressive tax system is based on the theory of diminishing marginal utility The utility of money goes on increasing because :1. Money is not one commodity. It is a claim on all commodities, since money is used to represent commodities, the homogeneity condition is not satisfied. 2. With less money one satisfies necessaries first and then turns to comforts and luxuries, when the stock of money is larger, the utility from additional unit goes on diminishing. 3. Wants are unlimited. Since money represents endless commodities. Its want can never be fully satisfied. So marginal utility of money can never be zero or negative. TU of money is always positive. Paradox of Value : The relationship between marginal utility and price helps to explain the paradox of value . Commodities like air and water have high utility but they command no price because they are available in abundance and have negligible marginal utility. In case of goods like diamonds the total utility is not high, but they command a high price because they are scarce and their marginal utility is high. Thus goods which have high value in use may have very little value in exchange and vice versa.