Utility Analysis

Introduction:
A consumer demands a good or a service. He demands a good because it gives him
utility. Wants – satisfying capacity of a good is called utility.

Meaning of Utility:
The term utility in economics is used to denote that quality in a commodity or service by virtue
of which our wants are satisfied. In other words, want – satisfying power of a good is called
utility.
Definitions:
According to Jevons, “Utility refers to abstract quality whereby an object serves
our purpose.

In the words of Hibdon, “Utility is the quality of good to satisfy a want.”

According to Mrs. Robinson, “Utility is the quality in commodities that makes

individuals wants to buy them”.

Utility differs from usefulness

A commodity may satisfy a human want, but may not be useful. For example-opium and poison,
but because they satisfy human wants and some people are ready to pay for them, means they
have utility for them. So a thing may be good or bad, but if it satisfies a human want, means it
possesses utility.

Utility is not synonymous with pleasure

A good, which posses utility, may not give pleasure when consumed e.g. , quinine, bit in spite of
its bitter taste quinine is purchased and consumed, for it does fulfill a need. Hence utility is not
the same thing a pleasure.

Forms of utility

• Forms utility. By changing the form of an article; we can give it greater utility, e.g. ; the
transformation of a log of wood into a piece of furniture.

• Place utility. Utility can also be increase by transporting a good from one place to
another.

When timber is brought to the market, it comes to have much greater utility than it had in
forest.

• Time utility. By storing a commodity and selling it at a time of scarcity, we can give it
greater utility.
 • Possession utility- The utility, which is rested with the right and authorized

Features:

Utility is Subjective: as it deals with the mental satisfaction of a man. A thing may have different
utility to different persons. E.g. Liquor has utility for drunkard but for person who is teetotaller,
it has no utility.

Utility is Relative: As a utility of a commodity never remains the same. It varies with
time and place. E.g. Cooler has utility in summer not during winter season.

Utility is not essentially Useful: A commodity having utility need not be useful. E.g. Liquor and
cigarette are not useful, but if these things satisfy the want of addict then they have utility for
him.

Utility is independent of Morality: It has nothing to do with morality. Use of opium liquor may not
be proper from moral point of view, but as these intoxicants satisfy wants of the opium – eaters,
drunkards, they have utility.

Concepts of Utility:

Initial Utility:
The utility derived from the first unit of commodity is called initial utility. It is obtained from the
consumption of the first unit of a commodity. It is always positive.

Total Utility:
The aggregate of utility obtained from the consumption of different units of a commodity, is
called Total utility.

Tux = f (Q x)

Tux = total utility of x is a function (f) of quantity of commodity x.

Marginal utility

Marginal utility can be defined as the change in the total utility resulting from
a one-unit change in the consumption of a commodity per unit of time.

Marginal utility is the increase in total utility resulting from the consumption
of the marginal unit. The following formula may be used to measure it.

Marginal utility=
Marginal Utility of Money
It is said that there can be a limit to the purchase of a commodity, but there
is no such limit to the acquiring of money. Money is a general purchasing
power. It enables the purchaser to buy anything he likes. That is why it is
said one can never reach a stage where money ceases to be desired. In
other words, more money a person has more he desires to obtain it.

Marginal Utility and Price

Marginal utility and price are inter-related. The two coincide, or price
measures marginal utility. The consumer stops where the price and the
marginal utility are equal. All units of the commodity being interchangeable,
what is paid for the marginal unit is paid for every other unit. Therefore we
can say that marginal utility determines price. It is marginal utility and not
total utility that determines price, otherwise the price of water should have
been high, and that of gold low.

Really, marginal does not determine price; it simply indicates it. The
determining factors are demand and supply. If the price changes, marginal
utility will change too. Price and marginal utility thus move together up and
down.

Marginal Utility and supply

Marginal utility is a function of supply, i.e., it varies with supply. In the case
of a free good, where the supply is unlimited, the marginal utility is zero.
Only in the case of scare goods is the marginal utility positive. It increases as
the supply is contracts and decreases as it expands. It comes down to zero
when the supply is super-abundant. Hence, marginal utility varies inversely
with supply, i.e., the greater the supply the less the marginal utility, and vice
versa.

Marginal utilities of related goods

There are two main types of relationship between goods: (a) They may be
substitutes; or (b) they may be complementary.

The substitutes are capable of satisfying the same want, e.g., tea and
coffee, air transport, rail transport and road transport. If they are perfect
substitutes, they may be treated as one commodity for all practical
purposes. But most goods are only imperfect substitutes. In the case of such
goods, other things being equal, the marginal utility of any such good
decreases as the quantity of the substitute goods with the consumer
increases.

Complementary goods are such goods which are wanted together for the
satisfaction of a want, e.g., paper, pen and ink for writing. In such cases,
other things remaining the same, marginal utility increases as the quantities
of the complementary goods with the consumer increases. If, for instance, a
consumer acquires more paper, the marginal utility of the bottle of ink goes
up.

Practical Importance of the Law of Diminishing Marginal

Utility
Taxation. The law of diminishing marginal utility has great practical
importance. We have seen that the law of diminishing marginal utility applies
to money too. This law forms the basis of the theory and practice of taxation.
Richer a person the higher is the rate of the tax he has to pay since to him
the marginal utility of money is less.

Price Determination. The law explains why, with increase in its supply, the
value of a commodity must fall. It thus forms a basis of the theory of value.
As such its practical importance both to the general consumer and the
business can hardly be exaggerated.

Household Expenditure. The law of diminishing marginal utility governs

our daily expenditure. Since we know that a larger purchase will mean lower
marginal utility, we restrict our purchase of a particular commodity, because
we cannot afford to waste our limited resources. We stop further purchases
at a point where marginal utility equals price.

Downward Sloping Demand Curve. It is this law which tells us why

demand curves slope downwards.

Value-in use and Value- in –Exchange. It also explains the divergence

between value-in-use and value –in-exchange. Air has great utility (value-in-
use) but little value-in-exchange, because it has no marginal utility.

Socialism. The socialists take stand on this law when they advocate the re-
distribution of wealth in favour of the poor. The marginal utility to the rich of
the wealth, that they might lose, is not so great as the marginal utility of the
wealth which is transferred to the poor.
Basis of Some Economic Laws. Some very important laws of Economics
are based on the law of diminishing marginal utility, e.g., Law of Demand,
the Concept of consumer’s surplus, the Concept of Elasticity of demand, the
law of Substitution, etc. These laws and concepts have ultimately been
derived from the law of diminishing marginal utility.

What Does Consumption Function Mean?

The consumption function is a mathematical formula laid out by famed economist John Maynard
Keynes. The formula was designed to show the relationship between real disposable income and
consumer spending, the latter variable being what Keynes considered the most important determinant of
short-term demand in an economy.

The consumption function is represented as:

Where:
C = Consumer spending
A = Autonomous consumption, or the level of consumption that would still exist even if income was $0
M = Marginal propensity to consume, which is the ratio of consumption changes to income changes
D = Real disposable income