THE MARGINAL UTILITY THEORY

What is Utility? It is in the human nature to demand things to satisfy needs. The satisfaction that a person gets after consuming or using a specific commodity, is often termed as utility. The drawback of the usage of this term is that it is not measurable with the help of any numerical unit.

In cases where the commodity is to be used, such as a cell phone, then utility is measured in accordance with usefulness. In cases where consumption is present, then it is observed in accordance with satisfaction after consumption.

Thus, utility is quite a time bound and relative

concept that depends upon the satisfaction

and usefulness that is felt after the

consumption of successive commodities. On

the whole, the concept is an abstract one.

Utility is a psychological phenomenon that is

used to gauge the satisfaction which is derived

from the consumption of goods and services. It

must be noted that the level of satisfaction that

is derived is abstract and also comparative.

There are two basic classifications of utility. For the purpose of explanation, let us take the example of apples. Imagine, that you have bought home a set of apples. There are two types of utilities that you can derive from the total amount of apples that we have consumed:

 Total Utility: The total utility is basically the

utility that you enjoyed while consuming the

entire set of apples.

Marginal Utility: Marginal utility on the other

hand, is the utility that you derived from the

consumption of each successive apple. You will

notice that the number of apples that you consume, go up with each passing unit that is consumed by you. A point comes, however when you shun the apple. When the utility becomes negative, you shift over to another fruit, instead of the apple.

THE LAW OF DIMINISHING MARGINAL UTILITY

The Law of Diminishing Marginal Utility states

that as the consumer consumes successive units

of a commodity, the utility that he derived from

every successive unit goes on decreasing

Prof. Marshall has defined the concept of

Diminishing Marginal Utility as follows:

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

Two important assumptions of the Theory of Diminishing Marginal Utility: 1. All units of the commodity consumed should be homogeneous 2. All the successive units should be consumed at a given point of time without any time gaps in between

No of Apples eaten

Total Utility

Marginal Utility

1 2 3

12 22 30

-----10 8

4
5 6 7 8

36
40 41 39 34

6
4 1 -2 -5

INDIFFERENCE CURVE ANALYSIS

Definition:
An Indifference Curve is a curve that shows different levels of satisfaction derived by a consumer when he consumes various combinations of two or more commodities

When a consumer goes to the market he usually

does not buy a single commodity but a BUNDLE OF

GOODS
A consumer is assumed to always choose THAT

bundle of goods which will give him maximum

satisfaction over all the other bundles

Which bundle a consumer would choose over all the other bundles will depend upon:

His tastes and preferences

Prices of the bundles of goods

His money income

An Indifference curve shows different

combinations of two commodities that a consumer

could possibly buy..

But all combinations of the two commodities on a

single Indifference curve will give the consumer the

same level of satisfaction

Indifference analysis is an alternative way of explaining consumer choice that does not require an explicit discussion of utility.
Indifference curve: a curve showing all the combinations of two goods (or classes of goods) that the consumer is indifferent among.

Indifference Curve

Utility and Preferences

Utility is the way economists represent preferences. Among two bundles, the one with the higher utility is the preferred bundle. If two bundles have the same utility, we say that the consumer is indifferent.

Properties of Indifference Curves

1. An Indifference Curve always slopes downward towards the right This property indicates the fact that out of the two given commodities, as the quantity of one

commodity increases in a consumers basket,

the quantity of the other commodity decreases

2.Every Indifference Curve to the right indicates a

higher level of satisfaction as compared to the

one on the left

A group of two or more Indifference Curves

showing various levels of satisfaction is known as

an Indifference Curve Map

Indifference Curves
Good 1

Good 2

3. Two Indifference Curves will never intersect each

other

This property is based on the concept of transitivity

4. An Indifference Curve is always convex to the origin

This property is based on the concept of

Diminishing Marginal Rate of Substitution

Marginal rate of substitution the rate at

which one factor must be added to compensate

for the loss of another factor, to keep output

constant.

Diminishing Marginal Rate of Substitution:

As a consumer consumes more and more units of

one commodity the rate at which he is ready to

substitute that commodity with another

commodity goes on decreasing

THE BUDGET LINE OR PRICE LINE

A Budget constraint represents the combinations

of goods and services that a consumer can

purchase given current prices with his or her

income. Consumer theory uses the concepts of a

budget constraint and a preference map to

analyze consumer choices.

Good Y

Good X

A Consumers Budget Constraint

A consumer is assumed to have a given income to spend in a single period on two goods The budget constraint says the spending on the two goods will equal the income available The consumer could choose not to spend all income, but this will not happen, since more is better.

Budget Line Shifts

When income, I, increases, the budget line shifts outward in parallel fashion. When Price of X increases, the budget line rotates inward

When Price of Y increases, the budget line rotates

inward

Consumer Optimization
A consumer will wish to obtain the highest possible utility that is feasible according to

the budget constraint

The consumer will choose a bundle to get on the

highest-utility indifference curve such that the

chosen bundle must be on or inside of the budget

Consumers Equilibrium