Utility

1. Definition: The amount of pleasure or happiness created through the consumption of a good
or a service is called utility. Example: if you eat your favorite ice cream, you will be happy.
What will happen in the second round? Happy, right? Will you be satisfied one after the other
rounds? No! The satisfaction of a consumer is the basis of the utility function. It measures how
much one enjoys when he or she buys something. A utility is a measure of how much one
enjoys a movie, favorite food, or other goods.
It varies with the amount of desire. One can conclude the following conclusions.
• A Utility of a good differs from one consumer to another.
• It keeps on changing for the same consumer due to the change in the number of desires.
• It should not be equated with its usefulness.
2. Characteristic of Utility

1. It is dependent upon human wants.

of a customer. It is measured in two ways:

3. a) Cardinal Approach: In this approach, one believes that it is measurable. One can express
his or her satisfaction in cardinal numbers i.e., the quantitative numbers such as 1, 2, 3, and so
on. It tells the preference of a customer in cardinal measurement. It is measured in utils.
Limitation of Cardinal Approach
1. In the real world, one cannot always measure utility.
2. One cannot add different types of satisfaction from different goods.
3. For measuring it, it is assumed that utility of consumption of one good is independent
of that of another.
4. It does not analyze the effect of a change in the price.

3.b) Ordinal Approach: In this approach, one believes that it is comparable. One can express
his or her satisfaction in ranking. One can compare commodities and give them certain ranks
like first, second, tenth, etc. It shows the order of preference. An ordinal approach is a
qualitative approach to measuring a utility.

Limitation of Ordinal Approach

1. It assumes that there are only two goods or two baskets of goods. It is not always true.
2. Assigning a numerical value to a concept of utility is not easy.
3. The consumer’s choice is expected to be either transitive or consistent. It is not always
possible.

4. Types of Utility: It is basically of three types: Total, Average and Marginal Utility.
a) Total Utility: The sum of the total satisfaction from the consumption of specific goods or

services. It increases as more goods are consumed.

Formula: Total Utility (T.U.) = U1 + U2 + … + Un

b) Marginal Utility: It is the additional satisfaction gained from each extra unit of
consumption. It decreases with each additional increase in the consumption of a good.

Formula: Marginal Utility (M.U.) = Change in T.U. / Change in Total Quantity = Δ TU/ Δ Q

c) Average Utility: One can obtain it by dividing the total unit of consumption by the number
of total units. Suppose there are total n units, then Average Utility will be Total utility /
Number of units.
Formula: Average Utility = T.U. / n

5. Relationship between total utility & marginal utility:

Unit TU AU MU
1 10 10 10
 2 18 9 8
3 24 8 6
4 28 7 4
5 30 6 2

6 30 5 0
7 28 4 -2

• From the above diagram, as long as marginal utility (MU) is positive, total utility (TU)
is increasing (TU 10, 18, 24……). This means that each additional unit consumed adds
to the total satisfaction or happiness.
• When MU is equal to zero, as in Unit 6, total utility reaches its maximum value at 30
util. This point is known as the point of satiation or satiety, where the consumer is fully
satisfied with the consumption of that good or service.
• Beyond the point of satiation, when MU becomes negative (that is -2), as in Unit 7,
total utility starts to decline. This indicates that the consumer is experiencing
diminishing satisfaction or happiness from consuming additional units.

In summary, the relationship between total utility and marginal utility is such that total utility
increases as long as marginal utility is positive, but it starts to decrease when marginal utility
becomes negative, reflecting the principle of diminishing marginal utility.

6. Law of Diminishing Marginal Utility: The law of diminishing marginal utility states that
as a consumer consumes more and more units of a specific commodity, utility from the
successive units goes on diminishing. Firstly, TU increases with consumption and once it falls
but MU always falls. TU curve is therefore inverse ‘U’- shaped and marginal utility curve slope
downwards.
The Law of Diminishing Marginal Utility is best understood through an analogy. Consider the
following example:

John is extremely hungry and goes to a restaurant that offers a buffet. He loads up his plate
with food and starts eating. The amount of satisfaction gained by John from a plate of food is
directly proportional to John’s hunger level. Therefore, the first plate of food will give John
more satisfaction (utility) than the second plate of food, which in turn will give John more
satisfaction than the third plate of food.
The situation above occurs because each plate of food reduces John’s hunger level. The
reduction in hunger level results in less satisfaction from the plate of food being consumed.
Each plate of food fills John up and thus lessens the amount of satisfaction he will get from the
plates of food that follow. Mathematically, it can be represented by the following table:

There is a graph to explain this law: Make an explanation