DS102 Microeconomics: Utility

Course Teacher:
Dr. M. Abu Eusuf

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 Utility Theory

Utility denotes satisfaction.

Utility is a measure of the satisfaction, happiness, or benefit
that results from the consumption of a good.
It refers to how consumers rank different goods and services.
If basket A has higher utility than basket B for someone Z, this
ranking indicates that Z prefers A over B.
In the theory of demand, we say that people maximize their
utility, which means that they choose the bundle of
consumption goods that they most prefer.
ØA util is an artificial construct used to measure utility.
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There are two views of utility:
n Cardinal Utility
n Cardinal utility is the belief that utility can be
measured and compared on a unit by unit
basis.
§ E.g., A utility measure of 200 is twice as big as a
utility measure of 100.
n Ordinal Utility
n Ordinal utility is where you rank bundles of
goods, but cannot say how much greater one
bundle is to another.
§ Ranking is the only thing that matters when dealing
with ordinal utility.

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 Total Utility & Marginal Utility
ØUtility tends to increase as we consume more of a
commodity.
ØTotal utility is the total satisfaction a person receives
from consuming a particular quantity of a good.
ØThe expression ‘marginal’ is a key term in
economics and always means ‘extra’.
ØMarginal utility is the additional utility a person
receives from consuming an additional unit of a
particular good.

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 A Numerical Example

Quantity (Q) Total Utility Marginal Utility

(TU) (MU)
0 0 4
1 4
2 7 3
3 9 2
4 10 1
5 10 0
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Marginal Utility
n Marginal utility is defined as the change in total utility
divided by a change in the consumption of a
particular good.
n In mathematical terms,
Marginal utility of good i = Δ Total Utility/ Δ in level of
consumption of one good
or Marginal utility of good i = Δ U/ Δ xi for i = 1, 2, …,
n
n Note that Δ means change

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Calculating Marginal Utility
n Suppose Arshiya/Badhan
only like to consume
chocolate. Number of chocolates Total
n Also, assume that Utility
Arshiya/Badhan’s total utility
they receive for eating 1 10
differing quantities of
chocolate is represented by 2 25
the following:
3 38
4 50
5 59
6 62
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 Calculating Marginal Utility…

Number of chocolates Total Marginal Utility

Utility
Δ U / Δ xi
1 10
15 = ((25-10)/(2-1))
2 25
13 = ((38-25)/(3-2))
3 38
12 = ((50-38)/(4-3))
4 50
9 = ((59-50)/(5-4))
5 59
3 = ((62-59)/(6-5))
6 62
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More Examples: Total Utility, Marginal Utility,
and the Law of Diminishing Marginal Utility

ØBoth total utility and marginal utility are

expressed in utils.
ØMarginal utility is the change in total
utility divided by the change in the quantity
consumed of the good, MU = ΔTU/ΔQ.
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Total Utility, Marginal Utility, and the Law of
Diminishing Marginal Utility…

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Law of Diminishing Marginal Utility

Ø The marginal utility gained by consuming equal

successive units of a good will decline as the amount
consumed increases.
Ø The total utility of something can be rising as the
marginal utility of that something is falling.

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Law of Diminishing Marginal Utility…

n This law states that as you consume more units or a

particular good during a set time, at some point your
marginal utility will decrease as your consumption
increases.
n Experiment: Go home and try consuming as much of a
particular good as you can.
n How do you feel after eating each additional unit?

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 CONSUMERS, PRODUCERS, AND
THE EFFICIENCY OF MARKETS
n Consumer surplus measures economic
welfare from the buyer’s side

n Producer surplus measures economic welfare

from the seller’s side.

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 CONSUMER SURPLUS
n Willingness to pay is the maximum amount
that a buyer will pay for a good.
n It measures how much the buyer values the
good or service.

n Consumer surplus is the buyer’s willingness

to pay for a good minus the amount the buyer
actually pays for it.

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 Consumer Surplus (CS)
CS is what we are prepared to pay minus what we
actually pay.
CS is measured by the difference between TU and the
amount spent
CS is to be found especially in the purchase of
commodities which are highly useful, but which are
very cheap
e.g. post card, newspaper, match box, salt, internet
etc.
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Four Possible Buyers’ Willingness to Pay

Buyer Willingness to pay (Tk.)

Mithila 100
Trina 80
Sufal 70
Labib 50

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 CONSUMER SURPLUS
n The market demand curve depicts the various
quantities that buyers would be willing and
able to purchase at different prices.

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The Demand Schedule for the Buyers in previous table

Price (Tk.) Buyers Quantity

Demanded

More than 100 None 0

81 to 100 Mithila 1

71 to 80 Mithila, Trina 2

51 to 70 Mithila, Trina, Sufal 3

50 or less Mithila, Trina, Sufal, Labib 4

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 The Demand Curve
Price of
Album

Tk.

100 Mithilas’s willingness to pay

80 Trina’s willingness to pay

70 Sufal’’s willingness to pay

50 Labib’s willingness to pay

Demand

0 1 2 3 4 Quantity
of Albums 19
 Measuring Consumer Surplus with the
Demand Curve Price of
Price of (a) Price = 80 Tk Album
(b) Price = 70 Tk
Album

100 100
Mithila’s consumer surplus (20
Tk) Mithilaa’s consumer surplus
(30 Tk)
80 80 Trina’s consumer surplus

70 (10 Tk.)
70

50 50
Total consumer
surplus (40 Tk.)

Demand

Demand

0 1 2 3 4 Quantity 0 1 2 3 4 Quantity
of Albums of Albums
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 Using the Demand Curve to Measure
Consumer Surplus
n The area below the demand curve and above
the price measures the consumer surplus in
the market.

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 How the Price Affects Consumer Surplus
(a) Consumer Surplus at a Price of P1 (b) Consumer Surplus at a Price of P2
Price Price

A A

Consumer surplus for new

consumers

C
P1 P1
B C B

Demand P2 F
D E
Additional
consumer
surplus to initial
consumers

0 Q1 Quantity 0 Q1 Q2 Quantity

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 What Does Consumer Surplus Measure?
n Consumer surplus, the amount that buyers
are willing to pay for a good minus the
amount they actually pay for it, measures the
benefit that buyers receive from a good as
the buyers themselves perceive it.

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 Consumer Surplus (CS)
Units TU MU Price
1 10 Tk 10 Tk 7 Tk
2 19 Tk 9 Tk 7 Tk
3 27 Tk 8 Tk 7 Tk
4 34 Tk 7 Tk 7 Tk

CS = 34 – 28 = 6 Tk
In case of market price 8, CS = 27 – 24 = 3 Tk.
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 Consumer Surplus (CS)
AT price OP
TU = OMQD, Cost = OMQP, CS = PQD
P, MU
AT price OP*
TU = OM*Q*D, Cost = OM*Q*P*, CS = P*Q*D
So, if price increases CS will decrease and vice-versa
D

P Q

P* Q*

D*
0 M M*
Units of commodity 25
Thank you!

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