Marginal Utility Analysis

Part 1 Assumptions of utilityanalysis:

1. Utility is based on the cardinal concept.
Part 2 2. Utility is measurable and additive of goods.
3. The marginal utility of money is assumed to be constant.
Part 3 4. The hypothesis of independent utility.
5. The consumer is rational.
6.He has full knowledge of the availability of commodities and their
Part 4
technical qualities.
7. Possesses perfect knowledge of the choice of commodities.
Part 5
8. There are no substitutes.
9. Utilities are not influenced by variations in their prices.
Part 6 10. The theory ignores complementary between goods.
 Law of diminishing marginal utility
Part 1
The law of marginal utility is based on the human wants. The law was first
developed by German Economist H.H Gossen which is known as
Part 2
“Gossen’s First law”. Later it was popularized by Prof. Alfred Marshall.

Part 3

Part 4 “The additional benefit which a person

derives from a given increase of his stock of a
thing diminishes with every increase in the
Part 5
stock that he already has”. - Alfred
Marshall
Part 6
 Law of diminishingmarginal utility
Part 1 Assumptions:
1. Tastes, preferences, etc of the customer remainconstant.
Part 2 2. Income of the consumer also remain constant
3. Units of the goods are identical or similar
4. The process of consumption is continuous.
Part 3 5. Units of the goods are not very small in size.
Importance:
Part 4 1. Framing taxation policy by the government.
2. Useful to consumer to regulate hisexpenditure.
Part 5 3.Useful to monopolist producer in fixing the prices of his
products.
4. Basis for law of demand.
Part 6 5. Differentiate value-in-use and value-in-exchange.
 Law of diminishing marginal utility
Part 1 Explanation of the law

•Suppose a person consumes the first apple, he derives the highest level
Part 2
of utility and the intensity of his desire declines.
• If he consumes the second apple, he will get lesser satisfaction
Part 3 than first apple.
• The utility that he gets from the third apple will be still less.
Part 4 •If he continues to consume more and more apples, utility from each
apple goes on diminishing as the intensity of his desire goes on
diminishing.
Part 5
Thus, the law of diminishing marginal utility simply tells us that we obtain
Part 6 less and less marginal utility from the successive units of a commodity as
we consume more and more of it
 Graphical representation
Part 1 Units of Margin
Total
apple utility al Diminishing MarginalUtility
consumed utility
Part 2 20
18 18
1 8 8 15 16
15 TU
13
Part 3 2 13 5 10

Utility
8
3 16 3 5 5
Part 4 3
2
4 18 2 0 0
1 2 3 4 5 6 -3 MU
Part 5 5 18 0 -5
Unitsofappleconsumed
6 15 -3
Part 6
 Explanation to thegraph
Part 1
•The Total Utility (TU) declines in positive rate but the
Part 2 Marginal Utility (MU) declines in a negativerate.

• Total utility rises by smaller amounts.

Part 3
•The negative slope of the marginal utility curve reflects the law of
Part 4 diminishing marginal utility.

• Saturation point is when the total utility isunchanged.

Part 5
• Marginal utility declines from larger to smaller units.
Part 6
 Limitations
Part 1 1. Different units consumed must be identical and the habit,
taste, income and treatment of the consumer also remain
Part 2 unchanged.
2. Different units consumed should be standard units.
Part 3 3. Continuous consumption. I.e. no gap between two
consumption of one unit and another unit.
Part 4 4. Law does not apply to articles like gold, cash, money,
music, hobbies,
Part 5 5. The shape of the utility curve may be affected by
the presence or absence of articles which are substitutes
Part 6 to it.
 Conclusion
Part 1
Utility reflects the tastes of a particular individual,
Part 2
uniqueness to the individual and reflects his or her
Part 3 own particular subjective
Part 4
preferences and perceptions. Utility remain
unchanged so long as the individual’s tastes remain
Part 5
the same.
Part 6
 Ordinal and cardinalapproach
Part 1
In order to attain this objective the consumer must be able to compare
the utility of the various commodities which can buy with his income.
Part 2 There are two basic approaches to the problem of comparison of utilities:
1. Cardinal approach 2. Ordinal approach
Part 3

Part 4

Part 5

Part 6
 Ordinal and cardinalapproach
Part 1 1. Ordinal approach: The ordinalist school postulated that utility is not
measurement, but is an ordinal magnitude. The consumer need not know
Part 2 in specific units the utility of various
commodities to make his choice. It is needed for him to rank the various
Part 3
commodities. He must be able to determine his
order of preference among the differentbundles
Part 4
of goods.
Part 5 The main ordinal theories are the
indifference-curves approach and the
Part 6 revealed preference hypothesis.
 Ordinal and cardinalapproach
Part 1
2. The cardinal approach The cardinalist school postulated that
utility can be measured. Various suggestions have been made for the
Part 2 measurement of utility.
Under certainty of full knowledge about the
Part 3
market conditions and income levels, some
Part 4 economists have suggested that utility can be
measured by monetary
Part 5 units; utils, by the amount of money the
consumer is willing to sacrifice for another
Part 6 unit of a commodity.
 Ordinal and cardinalapproach
Part 1 Ordinal Utility Cardinal Utility

Part 2 Consumption can’tbemeasured Consumption canbe measured

Uses utils which help in
Utility is used for grading/rankingof
understandinghow much utility is
Part 3 the products depending on the
derived from consumption of a
preferences of theconsumer
product.
Part 4
Much lesscompared Comparative study
Part 5 Conceptualand practical Precededthe ordinal approach
Convex function Concave function
Part 6
Qualitative measure Quantitative measure
 Conclusion
Part 1 Satisfaction from theconsumption
of a combination of goods and Satisfaction through consumption
services of one good atatime.
Part 2
Comparisonscanbe made of the
utility derived from two products, Focuseson the independent utility
Part 3 but the utilitycannot be computed derived fromaproduct
quantitatively.
Part 4 The ordinal approach will give a
sense of preferences, likes and
dislikesbut there is no numerical Though this approach brings out
measurement and this approachis the preference of one productover
Part 5 other through utils but this does
used in grading the preferencesof
the consumerdepending uponthe not imply anyconclusion or relation
alternatives that are available to between the choices
Part 6
him/her.
 Concept of consumerbehaviour:
Part 1 •Consumer behaviour is the study of how individual customers, groups
or organizations; select, buy, use, and dispose ideas, goods, and services
Part 2 to satisfy their needs and wants.

Part 3 •It refers to the actions of the consumers in the marketplace andthe
underlyingmotives for those actions.
Part 4
"Consumer behaviour is the decision process and
physical activity, which individuals engage in when
Part 5 evaluating, acquiring, using or disposing of goods and
services". - Louden and Bitta
Part 6
 Budget line:
Part 1
•A higher indifference curve shows a higher level of
Part 2 satisfaction than a lower one.
• A consumer in his attempt to maximise satisfaction will try to
Part 3 reach the higher possible indifference curve.
• In pursuit of buying more and more goods, he will obtain more and
Part 4 more satisfaction.
It includes twoconstraints:
Part 5 1. He has to pay the pricesfor the goods
2. He has a limited money income with which topurchase the
Part 6 goods.
 Budget line
Part 1 • A budget line shows all those combinations of two goods.
•The consumer can buy spending his given money income at
their given prices.
Part 2
•All those combinations which are within the reach of the consumer will
lie on the budget line.
Part 3
Consumer Budget states the
real income or purchasing
Part 4 20 power of the consumer from
----------Books--------

16
which he can purchase certain
Part 5
12

8
quantitative bundles of two
4
goods at given price.
0

Part 6 4
8 12 16 20 24 28 32 36 40

-------------Movies---------
 Key points for Budget line
Part 1 1. A Budget line separates what is affordable from what is not
affordable
Part 2 2. Budget line slopes downwardsas more of one good can be bought
by decreasing some units of the other good.
Part 3 3. Bundles which cost exactly equal to consumer ’s money
income lie on the budget line.
Part 4 4. Bundles which cost less than consumer ’s money income
shows under spending. They lie inside the budget line.
Part 5
5. Bundles which cost more than consumer’s money income are not
Part 6 available to the consumer. They lie outside the budget
line.
 Budget set
Part 1 A budget set or opportunity set includes all possible consumption bundles that
someone can afford with given the prices of goods and the person's income level. The
budget set is bounded above by the budget line.
Part 2
Y According to the graph
P •Good X and good Y are the two
Part 3 F commodities.
Budget line • PQ is the budget constraint or
budget line.
Part 4 •The possible consumption bundles of X
Good Y

C
E and Y are represented as A, B, C, D, E, F
Budget set D are within or on the budget constraint.
Part 5 B • If the combination of goods are above
A
the budget constraint, it is not taken into
Part 6 Q X consideration.
Good X
 Indifference Curve Analysis
Part 1
• A very popular, easier and scientific method of explaining
Part 2 consumer’s demand is the indifference curve analysis.
• This approach to consumer behaviour is based on consumer
Part 3 preferences.
•Human satisfaction is psychological phenomenon which cannot be
Part 4 measured in terms of monetary terms.
• This approach is more realistic to order preferences.
Part 5 •Consumer preference approach is therefore an ordinal concept based on
ordering of preferences compared with Marshall’s approach of
Part 6 cardinality.
 Indifference CurveAnalysis
Part 1 Indifference curve
An indifference curve is the locus of points- particular combinations or
Part 2 bundles of goods- which yield the same utility (level of satisfaction) to
the consumer, so that he is indifferent as to the particular combination
Part 3 he consumes.
In other words, an indifference curve is a graph showing combination of
Part 4 two goods that give the consumer equal satisfaction and utility. Each
point on an indifference curve indicates that a consumer is indifferent
Part 5 between the two and all points give him the same utility.
U = F(X, Y) = K
Part 6
 Indifference CurveAnalysis
Part 1 Assumptions of an Properties of an
indifferencecurve: indifference curve:
Part 2 1. Rational consumers. 1. Negative downwardslope
2. Two commodities 2. Further away from the origin
3. Utility isordinal an indifference curve
Part 3
4. Diminishing marginal rate of
lies.(Higher Indifference
substitution
Part 4 curves represent higher levels
5. Total utility of the consumer
depends on the quantities of of satisfaction)
Part 5 the commoditiesconsumed. 3. Indifference curve doesnot
6. Consistency and transitivity of intersect
Part 6 choice 4. Convex to the origin.
 Indifference Curve Analysis
Part 1
Y A l e v e l of Utility is a s s o c i a t e d w i t h e a c h
I n d i f f e r enc e C u r v e .
Part 2
All c o m b i n a t i o n s of X a n d Y a b o v e t h e
c u r v e a r e p r e f e r a bl e to c o m b i n a t i o n s
Part 3 a l o n g ow b e l o v e t h e
curve T h e i n d i v i dia l is
A ll A Indifferent b e t w e e n all
Part 4 combinations combinations of X and
of X a n d Y b e l o w Y along the
t h e c u r v e a r e inferior to curve
Part 5 t h o s e c o m b i n a t i o n s o n or
abo ve the curve
Part 6 X
 Indifference CurveAnalysis
Part 1
Combi- Food Clothing MRS Y
Part 2 nation 12 A
Convex to the origin
10
Part 3 A 1 12 0
8

Clothing
Utility obtained
B
Part 4 B 2 6 6 6 from point A,B,C,D
C are same D
4
C 3 4 2 IC
Part 5 2

D 4 3 1 1 2 3 4 5 6 X
Part 6 Food
 Indifference map
Part 1 Map shows all the indifference curves which rank the preferences of the
consumer.
Part 2
Combinations of goods
Part 3 situated on an indifference
curve yield higher level of
satisfaction and are
Part 4 preferred.
Combinations on the
Part 5 lower indifference curve
yield a lower utility.
Part 6
 Marginal Rate of Substitution
Part 1 MRS is the rate at which the consumer is prepared to exchange
goods X andY. Under the standard assumption of
Part 2 Y Neo-classical Economics, the
12
A
goods and services are:
Part 3 10
MRS=6
• Continuously divisible
8
-6
•The marginal rates of
B substitution will be the same
Part 4 6
MRS=1
1 -2 regardless of direction of
Clothing

4
C
1 -1 D exchange
Part 5 2 1 • It will correspond to the slope
of an indifference passing
Part 6
1 2 3 4 5 X through the consumption
Food
bundle.
 Marginal Rate of Substitution
Part 1 Explanation oflaw
• A person consumes1 unit of food and 12 units of clothing.
Part 2
• Then, he gives up 6 units of clothing to get an extra unit of food, his level
of satisfaction remaining the same. The MRS is 6.
Part 3
• Hence, He moves from B to C and from C to D inhis
indifference schedule, the MRS is 2 and 1 respectively.
Part 4 • MRS of X for Y as the amount of Y whose loss can just be
compensated by a unit gain of X, the level of satisfaction remains the
Part 5 same.
•As the consumer have more and more units of food; he is
Part 6 prepared to give up less and less units of cloths. Thus MRS is
diminishing.
 Optimal choice of the consumer/
Part 1
Consumer’s equilibrium
Part 2 After attaining the stage of indifference curve and budget
constraint, consumer has to reach equilibriumposition.
 A consumer derives maximum possible satisfaction from the
Part 3
goods at equilibriumposition.
 A consumer cannot rearrange his purchase of goods at that level.
Part 4 Assumptions:
1. The consumer has given indifference map which shows his
Part 5 scale of preferences for various combinations of two goods X and Y.
2.He has a fixed money income which he has to spend wholly on goodsX
and Y.
Part 6
3. The prices of goods X and Y are given fixed for him.
 Consumer’s equilibrium
According tothe graph:

Part 1 • IC1, IC2, IC3, IC4, IC5 are the indifferencecurves

• PL is the budget line for goods X and Y.
Part 2 • CombinationsR, S, Q, T, H cost the same.
Y The customer’s aim is to reach
Part 3 highest indifference curve which
P
R
maximises his satisfaction.
S
Part 4 R or H lies on alower
N Q indifference curve IC1,
IC5  S or T lies on alower
Part 5 T
IC4
indifference curve IC2,
IC3
H IC2

Part 6 IC1 Whereas IC4 and IC5 are

0 M L X beyond the consumer’s money
income.
 Consumer’s equilibrium
Part 1
“Consumer
will decideQ MUx MUy
Part 2 Utility maximisation rule: =
as the best Px Py
choicewhich
Part 3 lies on the if MUx > MUy buy more of 'x'
budget
line andalso
Px Py
Part 4
puts him on MUx MUy
highest if <buy more of 'y'
Part 5 possible Px Py
indifference
Part 6 curve IC3”.
 Consumer’s equilibrium
Part 1 Conclusion:

Part 2 •Thus the consumer will be at equilibrium at point Q on

IC3.
Part 3 • The consumerwill buy OM of X and ON of Y.
•Since there is a budget constraint, he will be forced to remain on the
Part 4 given budget line.
•He will have to choose only combinations which lie on the given price
Part 5 line.

Part 6