Meaning of Utility:
The simple meaning of ‘utility’ is ‘usefulness’. In economics utility is the capacity
of a commodity to satisfy human wants.
Utility is the quality in goods to satisfy human wants. Thus, it is said that “Wants
satisfying capacity of goods or services is called Utility.”
In this way utility is measured in terms of money and it is relative. There is
difference between utility and usefulness. A useful commodity may not here utility
of goods depend upon the intensity of wants.
Utility depends upon the intensity of want. When a want is unsatisfied or more
intense, there is a greater urge to demand a particular commodity which satisfies a
given want. In modern time utility has been called as ‘expected satisfaction.’
Expected satisfaction may be less or equal to or more than the real satisfaction.
Definition of Utility:
Various economists have defined utility as follows:
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2. According to Fraser:
“On the whole in recent years the wider definition is preferred and utility is
identified, with desireness rather than with satisfyingness.”
Characteristics of Utility:
The following are the important characteristic features of utility:
1. Utility has no Ethical or Moral Significance:
A commodity which satisfies any type of want, whether moral or immoral, socially
desirable or undesirable, has utility, i.e., a knife has utility as a household
appliance to a housewife, but it has also a utility to a killer for stabbing some body.
2. Utility is Psychological:
Utility of a commodity depends on a consumer’s mental attitude and assessment
regarding its power to satisfy his particular want. Thus, utility of a commodity may
differ from person to person. Psychologically, every consumer has his likes and
dislikes and everyone determines his own level of satisfaction.
For instance:
A consumer who is fond of apples may find a high utility in apples in comparison
to the consumer who has no liking for apples. Similarly a strictly vegetarian person
has no utility for mutton or chicken.
2. Place Utility:
This utility is created by transporting goods from one place to another. Thus, in
marketing goods from the factory to the market place, place utility is created.
Similarly, when food-grains are shifted from farms to the city market by the grain
merchants, place utility is created.
Transport services are basically involved in the creation of place utility. In retail
trade or distribution services too, place utility is created. Similarly, fisheries and
mining also imply the creation of place utility. Place utility of a commodity is
always more in an area of scarcity than in an area of scarcity than in an area of
abundance e.g., Kashmir apples are more popular and fetch higher prices in Pune
than in Srinagar on account of such place utility
3. Time Utility:
Storing, hoarding and preserving certain goods over a period of time may lead to
the creation of time utility for such goods e.g., by hoarding or storing food-grains
at the time of a bumper harvest and releasing their stocks for sale at the time of
scarcity, traders derive the advantage of time utility and thereby fetch higher prices
for food-grains. Utility of a commodity is always more at the time of scarcity.
Trading essentially involves the creation of time utility.
4. Service Utility:
This utility is created in rendering personal services to the customers by various
professionals, such as lawyers, doctors, teachers, bankers, actors etc.
For example:
If I am ready to pay Rs. 1500 for a watch and Rs. 2,000 for a Radio. Then I can say
that I derive utility from that watch up to the value of Rs. 1500; and from Radio up
to the value of Rs. 2,000. “The inference which we can draw from the above
example is that the price which we pay for any article is the utility which we derive
from that article.” But Prof. Hicks, Allen and Pareto have not supported Marshall’s
view of measuring utility.
They are of this opinion that measuring of utility is not possible because of the
following reasons:
(i) Utility is personal, psychological and abstract view which cannot be measured
like goods.
(ii) Utility is different for different people. Utility is always changeable and it
changes according to time and place. Therefore, it is difficult to measure such thing
who is of changeable nature.
(iii) Further, measuring material ‘money is not static. Value of money always
changes, therefore, correct measurement is not possible.
Kinds of Utility:
Utility are of three kinds:
(i) Marginal Utility,
It is the net addition to total utility made by the utility of the additional or extra
units of the commodity in its total stock. It has been said—as the last unit in the
given total stock of a commodity.
For example:
Suppose Mr. Shanker is consuming bread and he takes five breads. By taking first
unit he derives utility up to 20; second unit 16; third unit 12; fourth unit 8 and from
fifth 2. In this example the marginal unit is fifth bread and the marginal utility
derived is 2. If we will consume only four bread then the marginal unit will be
fourth bread and utility will be 8.
From the table given above it is clear that up to the consumption of the fifth bread
we receive positive utility; 6th unit is the unit of full satisfaction i.e., Utility derive
from that unit is zero. From 7th unit the utility received will be negative utility.
The table can be represented in shape of diagram as follows: In diagram No. 1 OX
axis (line) shows unit of bread and OY line shows the Marginal Utility received.
From the figure it is clear that from the first unit of bread utility received are 20
which has been shown on the top of the line.
Similarly 2, 3, 4, 5 Unit of bread’s utility is 16, 12, 8, 4 respectively All these have
been shown on OX line which shows positive marginal utility. Utility of the sixth
bread is zero and that of the seventh bread is negative and negative rectangle has
been shown below OX line.
Zero Utility:
When the consumption of a unit of a commodity makes no addition to the total
utility, then it is the point of Zero Utility. In our table the total utility, after the 6th
unit is consumed. This is the point of Zero Utility. It is thus seen that the total
utility is maximum when the Marginal Utility is zero.
Negative Utility:
Negative Utility is that utility where if the consumption of a commodity is carried
to excess, then instead of giving any satisfaction, it may cause dis-satisfaction. The
utility is such cases is negative. In the table given above the marginal utility of the
7th unit is negative.
For example:
Suppose, a man consumes five breads at a time. He derives from first bread 20
units of satisfaction from 16, from third 12, from fourth 8 and from fifth 4 i.e., total
60 units.
This can be shown by the following table:
It is clear from the above table that by the increasing use of any article Marginal
and Average Utility reduces gradually and Total Utility increases only up to that
point where the Marginal Utility comes to zero.
(ii) When Marginal Utility becomes zero; Total Utility will be maximum.
(iii) After zero when Marginal Utility is negative then there is reduction in Total
Utility.
Relationship between Marginal Utility and Total Utility can be studied from
the following:
From the above table it is clear that up to fourth bread Marginal Utility is positive
and there is no regular increase in the Total Utility. And on fifth bread the
Marginal Utility is zero and on this point the increase in Total Utility stops. This is
point of safety. As Prof. Bounding has said that “Point of full satisfaction and point
of full safety is that point where consumption increases but there is no increase in
Total Utility.” If after fifth bread, extra bread is consumed then there will be dis-
utility and Marginal Utility will be negative. Sixth and seventh bread shows dis-
utility.
The relationship between Marginal Utility and Total Utility will be shown by
diagram as follows:
In both the diagrams OX line shows bread. In diagram No. 1 OY line shows
Marginal Utility and is diagram No. 2 OY line shows Total Utility. As the number
of bread increases Marginal Utility goes on diminishing and Total Utility goes on
increasing—To remember:
(1) Marginal Utility goes on diminishing with the consumption of every additional
unit of bread.
(2) Total Utility goes on increasing with the consumption of every additional unit
but at a diminishing rate.
(3) Marginal Utility is equal to the increase in the Total Utility. Total Utility is the
sum total of the Marginal Utilities derived from all the units consumed.
(4) When Marginal Utility becomes 0, total utility does not increase.
(7) Since Marginal Utility diminishes, Total Utility increases at a diminishing rate.
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Can you tell how much are you satisfied from each of these items?
Probably you can tell which item you liked more. But, it is very
difficult to express “how much” you liked one over the other. It is
evident, that we need a more quantitative measure of satisfaction. Due
to this reason, economists developed the concept of utility.
Meaning of Utility:
Utility refers to want satisfying power of a commodity. It is the
satisfaction, actual or expected, derived from the consumption of a
commodity. Utility differs from person- to-person, place-to-place and
time-to-time. In the words of Prof. Hobson, “Utility is the ability of a
good to satisfy a want”.
After understanding the meaning of utility, the next big question is:
How to measure utility? According to classical economists, utility can
be measured, in the same way, as weight or height is measured. For
this, economists assumed that utility can be measured in cardinal
(numerical) terms. By using cardinal measure of utility, it is possible
to numerically estimate utility, which a person derives from
consumption of goods and services. But, there was no standard unit
for measuring utility. So, the economists derived an imaginary
measure, known as ‘Util’.
Utils are imaginary and psychological units which are used to measure
satisfaction (utility) obtained from consumption of a certain quantity
of a commodity.
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However, if you liked it more, you would give it a number greater than
20. Suppose, you assign 10 utils to the chocolate, then it can be
concluded that you liked the ice-cream twice as much as you liked the
chocolate.
TUn = U1 + U2 + U3 +……………………. + Un
Where:
ATU
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1 20 20
2 16 36
3 10 46
4 4 50
5 0 50
6 -6 44
In Fig. 2.1, units of ice-cream, are shown along the X-axis and TU and
MU are measured along the Y-axis. MU is positive and TU is
increasing till the 4th ice-cream. After consuming the 5th ice-cream, MU
is zero and TU is maximum.
This point is known as the point of satiety or the stage of maximum
satisfaction. After consuming the 6th ice-cream, MU is negative (known
as disutility) and total utility starts diminishing. Disutility is the
opposite of utility. It refers to loss of satisfaction due to consumption
of too much of a thing.
7.1 The Concept of Utility
Learning Objectives
Why do you buy the goods and services you do? It must be because they provide you with
satisfaction—you feel better off because you have purchased them. Economists call this
satisfaction utility.
The concept of utility is an elusive one. A person who consumes a good such as peaches gains
utility from eating the peaches. But we cannot measure this utility the same way we can measure
a peach’s weight or calorie content. There is no scale we can use to determine the quantity of
utility a peach generates.
Francis Edgeworth, one of the most important contributors to the theory of consumer behavior,
imagined a device he called a hedonimeter (after hedonism, the pursuit of pleasure):
“[L]et there be granted to the science of pleasure what is granted to the science of energy; to imagine an
ideally perfect instrument, a psychophysical machine, continually registering the height of pleasure
experienced by an individual…. From moment to moment the hedonimeter varies; the delicate index now
flickering with the flutter of passions, now steadied by intellectual activity, now sunk whole hours in the
neighborhood of zero, or momentarily springing up towards infinity” (Edgeworth, F. Y., 1967).
Perhaps some day a hedonimeter will be invented. The utility it measures will not be a
characteristic of particular goods, but rather of each consumer’s reactions to those goods. The
utility of a peach exists not in the peach itself, but in the preferences of the individual consuming
the peach. One consumer may wax ecstatic about a peach; another may say it tastes OK.
When we speak of maximizing utility, then, we are speaking of the maximization of something
we cannot measure. We assume, however, that each consumer acts as if he or she can measure
utility and arranges consumption so that the utility gained is as high as possible.
Total Utility
If we could measure utility, total utility would be the number of units of utility that
a consumer gains from consuming a given quantity of a good, service, or activity
during a particular time period. The higher a consumer’s total utility, the greater
that consumer’s level of satisfaction.
Panel (a) of Figure 7.1 “Total Utility and Marginal Utility Curves” shows the total
utility Henry Higgins obtains from attending movies. In drawing his total utility
curve, we are imagining that he can measure his total utility. The total utility curve
shows that when Mr. Higgins attends no movies during a month, his total utility
from attending movies is zero. As he increases the number of movies he sees, his
total utility rises. When he consumes 1 movie, he obtains 36 units of utility. When
he consumes 4 movies, his total utility is 101. He achieves the maximum level of
utility possible, 115, by seeing 6 movies per month. Seeing a seventh movie adds
nothing to his total utility.
Figure 7.1 Total Utility and Marginal Utility Curves
Panel (a) shows Henry Higgins’s total utility curve for attending movies. It rises as the number of movies increases, reaching a
maximum of 115 units of utility at 6 movies per month. Marginal utility is shown in Panel (b); it is the slope of the total utility
curve. Because the slope of the total utility curve declines as the number of movies increases, the marginal utility curve is
downward sloping.
Mr. Higgins’s total utility rises at a decreasing rate. The rate of increase is given by
the slope of the total utility curve, which is reported in Panel (a) of Figure 7.1
“Total Utility and Marginal Utility Curves” as well. The slope of the curve
between 0 movies and 1 movie is 36 because utility rises by this amount when Mr.
Higgins sees his first movie in the month. It is 28 between 1 and 2 movies, 22
between 2 and 3, and so on. The slope between 6 and 7 movies is zero; the total
utility curve between these two quantities is horizontal.
Marginal Utility
The amount by which total utility rises with consumption of an additional unit of a
good, service, or activity, all other things unchanged, is marginal utility. The first
movie Mr. Higgins sees increases his total utility by 36 units. Hence, the marginal
utility of the first movie is 36. The second increases his total utility by 28 units; its
marginal utility is 28. The seventh movie does not increase his total utility; its
marginal utility is zero. Notice that in the table marginal utility is listed between
the columns for total utility because, similar to other marginal concepts, marginal
utility is the change in utility as we go from one quantity to the next. Mr. Higgins’s
marginal utility curve is plotted in Panel (b) of Figure 7.1 “Total Utility and
Marginal Utility Curves” The values for marginal utility are plotted midway
between the numbers of movies attended. The marginal utility curve is downward
sloping; it shows that Mr. Higgins’s marginal utility for movies declines as he
consumes more of them.
Mr. Higgins’s marginal utility from movies is typical of all goods and services.
Suppose that you are really thirsty and you decide to consume a soft drink.
Consuming the drink increases your utility, probably by a lot. Suppose now you
have another. That second drink probably increases your utility by less than the
first. A third would increase your utility by still less. This tendency of marginal
utility to decline beyond some level of consumption during a period is called
the law of diminishing marginal utility. This law implies that all goods and
services eventually will have downward-sloping marginal utility curves. It is the
law that lies behind the negatively sloped marginal benefit curve for consumer
choices that we examined in the chapter on markets, maximizers, and efficiency.
One way to think about this effect is to remember the last time you ate at an “all
you can eat” cafeteria-style restaurant. Did you eat only one type of food? Did you
consume food without limit? No, because of the law of diminishing marginal
utility. As you consumed more of one kind of food, its marginal utility fell. You
reached a point at which the marginal utility of another dish was greater, and you
switched to that. Eventually, there was no food whose marginal utility was great
enough to make it worth eating, and you stopped.
What if the law of diminishing marginal utility did not hold? That is, what would
life be like in a world of constant or increasing marginal utility? In your mind go
back to the cafeteria and imagine that you have rather unusual preferences: Your
favorite food is creamed spinach. You start with that because its marginal utility is
highest of all the choices before you in the cafeteria. As you eat more, however, its
marginal utility does not fall; it remains higher than the marginal utility of any
other option. Unless eating more creamed spinach somehow increases your
marginal utility for some other food, you will eat only creamed spinach. And until
you have reached the limit of your body’s capacity (or the restaurant manager’s
patience), you will not stop. Failure of marginal utility to diminish would thus lead
to extraordinary levels of consumption of a single good to the exclusion of all
others. Since we do not observe that happening, it seems reasonable to assume that
marginal utility falls beyond some level of consumption.
Maximizing Utility
Economists assume that consumers behave in a manner consistent with the
maximization of utility. To see how consumers do that, we will put the marginal
decision rule to work. First, however, we must reckon with the fact that the ability
of consumers to purchase goods and services is limited by their budgets.
Suppose that in addition to movies, Mr. Higgins enjoys concerts, and the average
price of a concert ticket is $10. He must select the number of movies he sees and
concerts he attends so that his monthly spending on the two goods does not exceed
his budget.
To simplify our analysis, we shall assume that a consumer’s spending in any one
period is based on the budget available in that period. In this analysis consumers
neither save nor borrow. We could extend the analysis to cover several periods and
generate the same basic results that we shall establish using a single period. We
will also carry out our analysis by looking at the consumer’s choices about buying
only two goods. Again, the analysis could be extended to cover more goods and
the basic results would still hold.
The marginal decision rule states that an activity should be expanded if its
marginal benefit exceeds its marginal cost. The marginal benefit of this activity is
the utility gained by spending an additional $1 on the good. The marginal cost is
the utility lost by spending $1 less on another good.
This additional utility is the marginal benefit of spending another $1 on the good.
Suppose that the marginal utility of good X is 4 and that its price is $2. Then an
extra $1 spent on X buys 2 additional units of utility (MUX/PX=4/2=2). If the
marginal utility of good X is 1 and its price is $2, then an extra $1 spent on X buys
0.5 additional units of utility (MUX/PX=1/2=0.5).
The loss in utility from spending $1 less on another good or service is calculated
the same way: as the marginal utility divided by the price. The marginal cost to the
consumer of spending $1 less on a good is the loss of the additional utility that
could have been gained from spending that $1 on the good.
As the consumer buys more of good X and less of good Y, however, the marginal
utilities of the two goods will change. The law of diminishing marginal utility tells
us that the marginal utility of good X will fall as the consumer consumes more of
it; the marginal utility of good Y will rise as the consumer consumes less of it. The
result is that the value of the left-hand side of Equation 7.1 will fall and the value
of the right-hand side will rise as the consumer shifts spending from Y to X. When
the two sides are equal, total utility will be maximized. In terms of the marginal
decision rule, the consumer will have achieved a solution at which the marginal
benefit of the activity (spending more on good X) is equal to the marginal cost:
Equation 7.2
We can extend this result to all goods and services a consumer uses. Utility
maximization requires that the ratio of marginal utility to price be equal for all of
them, as suggested in Equation 7.3:
Equation 7.3
Consider, for example, the shopper introduced in the opening of this chapter. In
shifting from cookies to ice cream, the shopper must have felt that the marginal
utility of spending an additional dollar on ice cream exceeded the marginal utility
of spending an additional dollar on cookies. In terms of Equation 7.1, if good X is
ice cream and good Y is cookies, the shopper will have lowered the value of the
left-hand side of the equation and moved toward the utility-maximizing condition,
as expressed by Equation 7.1.
Even a small purchase, such as an ice cream bar, fails the strict test of being
divisible; grocers generally frown on requests to purchase one-half of a $2 ice
cream bar if the consumer wants to spend an additional dollar on ice cream. Can a
consumer buy a little more movie admission, to say nothing of a little more car?
In the case of a car, we can think of the quantity as depending on characteristics of
the car itself. A car with a compact disc player could be regarded as containing
“more car” than one that has only a cassette player. Stretching the concept of
quantity in this manner does not entirely solve the problem. It is still difficult to
imagine that one could purchase “more car” by spending $1 more.
Remember, though, that we are dealing with a model. In the real world, consumers
may not be able to satisfy Equation 7.3 precisely. The model predicts, however,
that they will come as close to doing so as possible.