Consumer Behavior : Utility Analysis

Utility

Utility refers to want satisfying power of a commodity. In objective terms, utility may be defined as the amount of satisfaction derived from a commodity or service at a particular time. Assumptions:
Utility can be measured. Marginal Utility of money remains constant No change in income of the consumer, his taste & fashion to be constant No substitute Independent marginal utility of each unit of commodity

Total Utility (TU) and Marginal Utility (MU)

Total Utility refers to the total satisfaction derived by the consumer from the consumption of a given quantity of a good. TU = Sum of all MU

Marginal utilityMUrefers the additional satisfaction from one more unit of consumption
The exponents of the utility analysis have developed two laws which occupy a very important place in economics theory and they are :# Law of Diminishing Marginal Utility # Law of Equi-Marginal Utility

Cardinal Utility & Ordinal Utility

Cardinal utility believes that utility

could be measured & added (utility unit & marginal analysis);

Ordinal utility holds that utility

could only be ordered and cannot be measured (indifference curve).

Law of Diminishing Marginal Utility

Though wants of an individual are unlimited in number yet each individual want is satiable. Because of this, the more we have a commodity, the less we want to have more of it. This law state that as the amount consumed of a commodity increases, the utility derived by the consumer from the additional units, i.e marginal utility goes on decreasing. According to Marshall, The additional benefit a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has

Law of Diminishing Marginal Utility

Explanation: As more and more quantity of a commodity is consumed, the intensity of desire decreases and also the utility derived from the additional unit. Assumptions: All the units of a commodity must be same in all respects The unit of the good must be standard There should be no change in taste during the process of consumption There must be continuity in consumption There should be no change in the price of the substitute goods

Relationship between MU and TU Units of a goods Marginal Total consumed Utility (MU) utility (TU) 1 6 6 2 4 10 3 2 12 4 0 12 5 -2 10 6 -4 6

Law of Equi-Marginal Utility

This law states that the consumer maximizing his total utility will allocate his income among various commodities in such a way that his marginal utility of the last rupee spent on each commodity is equal. Or The consumer will spend his money income on different goods in such a way that marginal utility of each good is proportional to its price

MU of A / P of A = MU of B / P of B

Limitations of Law of Equi-Marginal Utility

It is difficult for the consumer to know the marginal utilities from different commodities because utility cannot be measured. # Consumer are ignorant and therefore are not in a position to arrive at an equilibrium. # It does not apply to indivisible and inexpensive commodity.
#

Equi Marginal Utility Marginal Utility of Marginal Utility Rupee Apples of Oranges 1 10 7 2 8 6 3 6 5 4 4 4 5 2 3 Total Money available is Rs.5 to be spent on Apples and Oranges. Price of both comodities is Re.1 per unit.

Indifference curve
A locus of points representing different bundles of goods and services, each of which yields the same level of total utility.

Constructing an indifference curve

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0

Pears Oranges 30 24 20 14 10 8 6 6 7 8 10 13 15 20

Point a b c d e f g

Pears

10

12

14

16

18

20

22

Oranges

Deriving the marginal rate of substitution 30 a (MRS)

26

Units of good Y

20

10

0 0
67

10

20

Units of good X

Deriving the marginal rate of substitution 30 a (MRS) DY = 4 MRS = 4

26

b DX = 1

Units of good Y

20

10

0 0
67

10

20

Units of good X

Deriving the marginal rate of substitution 30 a (MRS) DY = 4 MRS = 4

26

b DX = 1

Units of good Y

20

10 9

DY = 1

MRS = 1 d

DX = 1

0 0
67

10

13 14

20

Units of good X

30 An indifference map

Units of good Y

20

10

I5 I2
20

I3

I4

0 0 10

I1 Units of good X

30 a A budget line
Units of good X Units of Point on good Y budget line
30 20 10 0

Units of good Y

20

0 5 10 15

a b

10

Assumptions PX = 2 PY = 1 Budget = 30

0 0 5 10 15 20

Units of good X

Effect of an increase in income on the 40 budget line Assumptions

30

Units of good Y

PX = 2 PY = 1 Budget = 40

20
16

10

Budget = 40 Budget = 30
0 5
7

0 10

15

20

Units of good X

Effect on the budget line of a fall in the price 30 a of good X Assumptions

Units of good Y
20
PX = 1 PY = 1 Budget = 30

10

B1
0 0 5 10

B2
b c
20 25 30

15

Units of good X

Finding the optimum consumption

Units of good Y

Budget line

I5 I2 I3 I4

I1 O Units of good X

Same slope at t of indifference curve and budget line

r s Units of good Y

Y1

u v I1 O X1 Units of good X I2 I3

I5 I4

Effect on consumption of a change in income

Units of good Y

B1 O Units of good X

I1

Effect on consumption of a change in income

Units of good Y

B1 O

B2

I1

I2

Units of good X

Effect on consumption of a change in income

Units of good Y

I4 I3 B1 O Units of good X B2 B3 B4 I1 I2

Effect on consumption of a change in income

Units of good Y

Incomeconsumption curve

I4 I3 B1 O Units of good X B2 B3 B4 I1 I2

30 Effect of a fall in the price of good X

Assumptions PX = 2 PY = 1 Budget = 30

Units of good Y

20

10

0 0 5 10

B1
15 20 25

I1
30

Units of good X

30 Effect of a fall in the price of good X a

Assumptions PX = 1 PY = 1 Budget = 30

Units of good Y

20

k j

10

I2

0 0 5 10

B1
15 20 25

I1

B2
30

Units of good X

30 Effect of a fall in the price of good X a

Priceconsumption curve Units of good Y

20

k j

10

I2

0 0 5 10

B1
15 20 25

I1

B2
30

Units of good X