ECONOMICS NOTES- CHAPTER 30 22/06/2026

What is Utility?

The Price System and

• In economics, utility is a measure of preferences over
Microeconomics some set of goods and services; it represents
satisfaction experienced by the consumer from a
good.
Utility

Cardinal Utility vs. Ordinal Utility Util

• Cardinal Utility: Assigning numerical values to the amount of satisfaction.

It is the unit used to measure utility
• Ordinal Utility: Not assigning numerical values to the amount of
satisfaction but indicating the order of preferences, that is, what is
preferred to what.
• Various theories have been developed to explain consumer behaviour
• 1. Cardinal utility analysis - Marginal utility analysis
• [Link] utility analysis - Indifference curve analysis

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Total Utility Marginal Utility

•The amount of satisfaction obtained by consuming specified amounts • Marginal utility theory examines the increase in satisfaction consumers gain
of a product per period of time. from consuming an extra unit of a good.
•The aggregate level of satisfaction or fulfillment that a consumer • Utility is an idea that people get a certain level of satisfaction/happiness / utility
receives through the consumption of a specific good or service. from consuming goods and service.
•Each individual unit of a good or service has its own marginal utility, • Marginal utility is the benefit of consuming an extra unit
and the total utility is simply the sum of all the marginal utilities of the
individual units.

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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, the marginal utility from the
successive units goes on diminishing”

Text Link

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LAW OF DIMISHING MARGINAL UTILITY Equi marginal Utility

• [Link] • The equi-marginal principle states that a consumer will be maximizing

his total utility when he allocates his fixed money income in such a
way that the utility derived from the last unit of money spent on each
good is equal.

Price of X = 1, Price of Y = 2 and income of consumer = 10

Equi marginal Principle

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How it will impact the consumer’s buying behavior if Price of Y come

downs to 1.
Assumptions....

DERIVATION OF DEMAND GRAPH FROM

EQUI MARGINAL UTILITY
MARGINAL UTILITY
• [Link] • [Link]

• [Link]

• [Link]

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Demand curve and diminishing utility LIMITATIONS OF MARGINAL UTILITY THEORY

• The fundamental reasons for demand curve to slope downward are • (1) Measurability of utility
as follows: • (2) Irrationality by the consumer or ignorance of the consumer
(i) Law of diminishing marginal utility: The law of demand is based on • 3) Slave of customs and habits
the law of diminishing marginal utility. According to the cardinal
utility approach, when a consumer purchases more units of a • (4) Indivisible commodities
commodity, its marginal utility declines. • (5) Not applicable to free goods
(ii) The consumer, therefore, will purchase more units of that • (6) Changes in prices
commodity only if its price falls. Thus a decrease in price brings • 7) Marginal Utility of money does not remain constant
about an increase, in demand. The demand curve, therefore, is
downward sloping.

Meaning of a Rational Consumer Are consumers rational

• A rational consumer is considered to be that person who makes • The assumption that the consumers behave rationally at all times is
rational consumption decisions. In other words, the consumer who not true. Emperical eveidence shows that there are other Behavioural
makes his choices after considering all the other alternative goods factors that affect the consumers choice.
(and services) available in the market is called a rational consumer. • for example:
• Consumers purchase a product by testing, comparing and observing • Advertisement
the product keenly in terms of price, quality and durability.
• special discounts
• Deffered payments

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Behavioral economics Behavioural Economics VS Rational Behaviour

• Behavioral economics studies the effects of psychological, • Behavioural Economics is a method of economic analysis that applies
cognitive(thinking), emotional, cultural and social factors on the psychological insights into human behaviour to explain economic
decisions of individuals and institutions and how those decisions vary decision-making
from those implied by classical economic theory. • A rational behaviour decision-making process is based on making
choices that result in the most optimal level of benefit or utility for
the individual. Most conventional economic theories are created and
used under the assumption all individuals taking part in an
action/activity are behaving rationally.

Ques....
• (a) Explain how utility theory can be used to determine
the downward slope of a demand curve.[12]
• Explanation of utility, assumption of given tastes, • The law of demand is based on the law of diminishing marginal utility.
income, relation to price, equilibrium point and According to the cardinal utility approach, when a consumer purchases
quantity purchased, result of changes in price to more units of a commodity, its marginal utility declines. The consumer,
therefore, will purchase more units of that commodity only if its price
• construct demand curve. falls. Thus a decrease in price brings about an increase, in demand. The
• The fundamental reasons for demand curve to slope demand curve, therefore, is downward sloping.
downward are as follows: (i) Law of diminishing
marginal utility: The law of demand is based on the law
of diminishing marginal utility. According to the cardinal •
utility approach, when a consumer purchases more
units of a commodity, its marginal utility declines.

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