UTILITY

Key Points to be discussed :

 Utility
 Cardinal Utility Vs Ordinal Utility
 Total Utility and Marginal Utility
 Law of Diminishing Marginal Utility
 Law of Equi-marginal utility
 Exception or Limitation of Law of Marginal

Utility
 Graphical Presentation of Total Utility &

Marginal Utility.
UTILITY
 What Is Utility?
 Utility is an economic term coined by the noted 18th
century Swiss mathematician Daniel Bernoulli
referring to the total satisfaction received from
consuming a good or service. Economic theories
based on rational choice usually assume that
consumers will strive to maximize their utility. The
economic utility of a good or service is important to
understand because it will directly influence the
demand, and therefore price, of that good or service.
A consumer's utility is impossible to measure;
however, some economists believe that they can
indirectly estimate utility by various means.
Utility
 Utility: The amount of happiness or pleasure created
through the consumption of a good or a service is
called utility.
 There are different schools of thought regarding the
measurability of utility.
 Ordinalists believe that utility can’t be measured ,
can only be compared. For example , an individual
can say that his utility from the consumption of an
apple is greater than utility from an orange.
 Cardinalists, on the other hand , opine that individual
knows for certain- how much utility is obtained from
the consumption of an apple or an orange.
Utility
 Total Utility: Amount of satisfaction obtained from
the consumption of a certain quantity of a good or
service is called total utility.
 Marginal Utility : Change in total utility due to
change one unit of consumption is called marginal
utility.
 MU=
 MU=
 MU=8


 MU= (TU), U= 100q-

 MU= 100-2q
UTILITY
 Difference Between Cardinal and Ordinal Utility

 The utility is a psychological phenomenon; that implies the

satisfying power of a good or service. It differs from person to
person, as it depends on a person’s mental attitude. The
measurability of utility is always a matter of contention. The
two principal theories for the utility are cardinal utility and
ordinal utility. Many traditional economists hold the view that
utility is measured quantitatively, like length, height, weight,
temperature, etc. This concept is known as cardinal
utility concept.
 On the other hand, ordinal utility concept expresses the
utility of a commodity in terms of ‘less than’ or ‘more than’.
Take a read of the article to know the important differences
between cardinal and ordinal utility.
Cardinal utility
 Definition of Cardinal Utility
 The notion of Cardinal utility was formulated by Neo-classical
economists, who hold that utility is measurable and can be
expressed quantitatively or cardinally, i.e. 1, 2, 3, and so on.
The traditional economists developed the theory of
consumption based on cardinal measurement of utility, for
which they coined the term ‘Util‘ expands to Units of utility. It
is assumed that one util is equal to one unit of money, and
there is the constant utility of money.
 Further, it has been realized with the passage of time that the
cardinal measurement of utility is not possible, thus less
realistic. There are many difficulties in measuring utility
numerically, as the utility derived by the consumer from a
good or service depends on a number of factors such as
mood, interest, taste, preferences and much more
Ordinal Utility
 Definition of Ordinal Utility
 Ordinal Utility is propounded by the modern economists, J.R.
Hicks, and R.G.D. Allen, which states that it is not possible for
consumers to express the satisfaction derived from a
commodity in absolute or numerical terms. Modern Economists
hold that utility being a psychological phenomenon, cannot be
measured quantitatively, theoretically and conceptually.
However, a person can introspectively express whether a good
or service provides more, less or equal satisfaction when
compared to one another.
 In this way, the measurement of utility is ordinal, i.e.
qualitative, based on the ranking of preferences for
commodities. For example: Suppose a person prefers tea to
coffee and coffee to milk. Hence, he or she can tell
subjectively, his/her preferences, i.e. tea > coffee > milk.
UTILITY
 Key Differences Between Cardinal and Ordinal Utility
 The following points are noteworthy so far as the difference
between cardinal and ordinal utility is concerned:
 Cardinal utility is the utility wherein the satisfaction derived
by the consumers from the consumption of good or service
can be measured numerically. Ordinal utility states that the
satisfaction which a consumer derives from the consumption
of product or service cannot be measured numerically.
 Cardinal utility measures the utility objectively, whereas
there is a subjective measurement of ordinal utility.
 Cardinal utility is less realistic, as quantitative measurement
of utility is not possible. On the other end, the ordinal utility
is more realistic as it relies on qualitative measurement.
UTILITY

 Cardinal utility, is based on marginal utility

analysis. As against this, the concept of ordinal
utility is based on indifference curve analysis.
 The cardinal utility is measured in terms of utils,
i.e. units of utility. On the contrary, the ordinal
utility is measured in terms of ranking of
preferences of a commodity when compared to
each other.
 Cardinal utility approach propounded by Alfred
Marshall and his followers. Conversely, ordinal
utility approach pioneered by Hicks and Allen.
Utility analysis
 The Definition of Total Utility
 If utility is cardinal and measurable, the
total utility (TU) is defined as the sum of the
satisfaction that a person can receive from the
consumption of all units of a specific product
or service. Using the example above, if a
person can only consume three slices of pizza
and the first slice of pizza consumed yields 10
utils, the second slice of pizza consumed
yields 8 utils and the third slice yields 2 utils,
the total utility of pizza would be 20 utils.
Utility analysis
 The Definition of Marginal Utility
 Marginal utility (MU) is defined as the additional
(cardinal) utility gained from the consumption of one
additional unit of a good or service or the additional
(ordinal) use that a person has for an additional unit.
Using the same example, if the utility of the first slice
of pizza is 10 utils and the utility of the second slice is
8 utils, the MU of eating the second slice is 8 utils. If
the utility of a third slice is 2 utils, the MU of eating
that third slice is 2 utils. In ordinal utility terms, a
person might eat the first slice of pizza, share the
second slice with their roommate, save the third slice
for breakfast, and use the fourth slice as a doorstop.
Utility analysis
 Utils:
 'Utils' is considered as the measurable 'unit' of utility.
 Explanation for the Law of Diminishing Marginal Utility:
 We can briefly explain Marshall’s theory with the help of an
example. Assume that a consumer consumes 6 apples one
after another. The first apple gives him 20 utils (units for
measuring utility). When he consumes the second and third
apple, the marginal utility of each additional apple will be
lesser. This is because with an increase in the consumption of
apples, his desire to consume more apples falls.
 Therefore, this example proves the point that every successive
unit of a commodity used gives the utility with the diminishing
rate.
 We can explain this more clearly with the help of a schedule
and diagram.
Utility analysis
 Assumptions of Law of diminishing utility:
 Units of goods are homogenous.
 No time gap between the consumption of

the different units.

 Tastes, fashion, preferences, and priorities

remain unchanged.
 Consumer aims at maximum satisfaction.
 Consumer’s income is fixed and limited.
Utility analysis
 Law of Diminishing Marginal Utility:
 The law of diminishing marginal utility is
comprehensively explained by Alfred Marshall.
According to his definition of the law of
diminishing marginal utility, the following
happens:
 “During the course of consumption, as more
and more units of a commodity are used, every
successive unit gives utility with a diminishing
rate, provided other things remaining the
same; although, the total utility increases.”
Law of Diminishing Marginal Utility

We know that Utility is the capacity of a commodity

through which human wants are satisfied.
 Law of Diminishing Marginal Utility:
The law of diminishing marginal utility is
comprehensively explained by Alfred Marshall.
According to his definition of the law of diminishing
marginal utility, the following happens:
“During the course of consumption, as more and
more units of a commodity are used, every
successive unit gives utility with a diminishing rate,
provided other things remaining the same; although,
the total utility increases.”
Law of Diminishing Marginal Utility

 Assumptions in the Law of Diminishing Marginal Utility:

For the law of diminishing marginal utility to be true, we need to
make certain assumptions. Each assumption is quite logical and
understandable. If any of the assumptions are not true in the case,
the law of diminishing marginal utility will not be true.
Following are the assumptions in the law of diminishing marginal
utility:
 The quality of successive units of goods should remain the same. If
the quality of the goods increase or decrease, the law of diminishing
marginal utility may not be proven true.
 Consumption of goods should be continuous. If there comes a
substantial break in the consumption of goods, the actual concept of
diminishing marginal utility will be altered.
 Consumer’s mental outlook should not change.
 Unit of good should not be very few or small. In such a case, the
utility may not be measured accurately.
Law of Diminishing Marginal Utility

Schedule for Law of Diminishing Marginal Utility:

Unit of Total Utility Marginal

Consumption Utility
1 20 20
2 35 15
3 45 10
4 that with each additional
The schedule explains 50 unit consumed 5 the marginal utility
increases with a diminishing
5 rate. After 50
the saturation point though,
0 the utility
starts to fall.
6 45 -5
Law of Diminishing Marginal Utility
In the above table, the total utility obtained from the
first apple is 20 utils, which keep on increasing until
we reach our saturation point at 5th apple. On the
other hand, marginal utility keeps on diminishing with
every additional apple consumed. When we consumed
the 6th apple, we have gone over the limit. Hence, the
marginal utility is negative and the total utility falls.
With the help of the schedule, we have made the
following diagram:
Total utility & Marginal Utility
Law of Diminishing Marginal Utility
Saturation Point: The point where the desire to consume
the same product anymore becomes zero.
Disutility: If you still consume the product after the
saturation point, the total utility starts to fall. This is known
as disutility.
When the first apple is consumed, the marginal utility is
20. When the second apple is consumed, the marginal
utility increases by 15 utils, which is less than the marginal
utility of the 1st apple – because of the diminishing rate.
Therefore, we have shown that the utility of apples
consumed diminishes with every increase of apple
consumed.
 Similarly, when we consumed the 5th apple, we are at

our saturation point. If we consume another apple, i.e.

6th apple, we can see that the marginal utility curve has
fallen to below X-axis, which is also known as ‘disutility’.
Utility analysis
 Law of Equi-Marginal Utility explains the
relation between the consumption of two or
more products and what combination of
consumption these products will give
optimum satisfaction. Marginal Utility is the
additional satisfaction gained by consuming
one more unit of a commodity.
Utility Analysis
 Assumptions of the Law
 There is no change in the price of the goods or
services.
 The consumer has a fixed income.
 The marginal utility of money is constant.
 A consumer has perfect knowledge of utility.
 Consumer tries to have maximum satisfaction.
 The utility is measurable in cardinal terms.
 There are substitutes for goods.
 A consumer has many wants.
Utility analysis
 Law of Equi-Marginal Utility
 This law is based on the principle of obtaining maximum
satisfaction from a limited income. It explains the behavior of
a consumer when he consumes more than one commodity.
 The law states that a consumer should spend his limited
income on different commodities in such a way that the last
rupee spent on each commodity yield him equal marginal
utility in order to get maximum satisfaction.
 Suppose there are different commodities like A, B, …, N. A
consumer will get the maximum satisfaction in the case of
equilibrium i.e.,
 MUA / PA = MUB / PB = … = MUN / PN
 Where MU’s are the marginal utilities for the commodities
and P’s are the prices of the commodities.
Utility analysis
=2, =1, Budget =maximum 7
Unit
1 10 6
2 8 5
3 6 4
4 4 3
5 2 2
Utility Analysis
 Limitation of the Law
There are some limitations to this law. They are
 The law is not applicable in case of knowledge. Reading

books provides more knowledge and has more utility.

 This law is not applicable in case of fashion and

customs.
 This law is not applicable for very low income.
 There is no measurement of utility.
 Not all consumer care for variety.
 The law fails when there are no choices available for the

good.
 The law fails in case of frequent price change.
Law of Diminishing Marginal Utility
 Exceptions for the Law of Diminishing
Marginal Utility:
 The law of diminishing marginal utility states that

with the consumption of every successive unit of

commodity yields marginal utility with a
diminishing rate. However, there are certain
things on which the law of diminishing marginal
utility does not apply.
Following are the exceptions for this law:
 Desire for money.

 Desire for knowledge.

 Use of liquor or wine.

 Collection of rare objects.

Law of Diminishing Marginal Utility
 The exceptions or limitations to the law of diminishing utility.


 (i) Case of intoxicants: Consumption of liquor defies the low

for a short period. The more a person drinks, the more likes it.
However, this is truer only initially. A stage comes when a
drunkard too starts taking less and less liquor and eventually
stops it.

 (ii) Rare collection: If there are only two diamonds in the

world, the possession of 2nd diamond will push up the marginal
utility.

 (iii) Application to money: The law equally holds good for

money. It is true that more money the man has, the greedier he
is to get additional units of it. However, the truth is that the
marginal utility of money declines with richness but never falls
to zero.
utility
Exceptions Of The Law Of Diminishing Marginal Utility
There are various limitations / exceptions of the law of diminishing
marginal utility. Major limitations are as follows:

1. Homogeneous Commodity
The law of diminishing marginal utility assumes that there should be single
commodity with homogeneous units. All units of the commodity should be
of the same size and quality. If the units are not identical, this law will not
be applied.

2. No change in tastes, habits, customs, fashion and income of the

consumer
There should not be changed in tastes, habits, customs, fashion and
income of the consumer. If the income of a consumer increases, the
marginal utility of a certain goods will increase. In such case, increase in
consumption may yield greater satisfaction or utility.
utility

3. Continuity
There should be continuity in the consumption of the
commodity; otherwise the law of diminishing marginal utility will
not apply. Units of the commodity should be consumed in
succession at one particular time. If the interval between the
various units of consumption is too long, marginal utility may
become higher..

4. Suitable size of units

Units of the commodity should be of a suitable size. It must
not be too small. For example, giving water to a thirsty man by
spoon will increase the utility of the successive spoon of water.
Utility

5. Ordinary commodities
Commodities should be of an ordinary types. If the commodities are likes
diamonds and jewels or hobby commodities like stamps, coins or paintings, the
law of diminishing marginal utility does not apply.

6. Marginal utility of money not constant

Our intensity for money increases as we have more of it. No doubt the
marginal utility of money does not become zero, but it definitely falls as a
person gets more and more money. The marginal utility of money for a rich is
less than a poor man.

7. Rational consumer
The consumer should be an economic man, who acts rationally. This law does
not apply to persons of special nature such as drunkard, druggist etc. Marginal
utility of wine for drunkard increases with every peg of drinks.
Utility Analysis
 Importance of the Law
 This law is helpful in the field of production. A producer
has limited resources and tries to get maximum profit.
 This law is helpful in the field of exchange. The
exchange is of anything like some goods, wealth,
trade, import, and export.
 It is applicable to public finance.(tax, subsidy)
 The law is useful for workers in allocating the time
between the work and rest.
 It is useful in case of saving and spending.
 It is useful to look for substitution in case of price rise.
