Consumers Behavior
MARGINAL UTILITY
ANALYSIS
Learning Objectives
define total utility and marginal utility
understand law of diminishing marginal utility
describe relationship between total and marginal utility
demonstrate demand curve
define marginal utility of money
illustrate consumer equilibrium
MARGINAL UTILITY ANALYSIS
Two Questions in Consumers
Behavior
The first one is: why does a consumer
demand a good or service.
The second question: how should a
consumer spend his limited income
on different goods and services
What is Utility?
Satisfaction, happiness, benefit
What is Util?
A unit of measure of utility
Cardinal Utility vs. Ordinal Utility
Cardinal Utility:
Assigning numerical values to the amount of
satisfaction
Ordinal Utility:
Not assigning
amount of
numerical
values
to
the
satisfaction but indicating the order of
preferences, that is, what is preferred to what
Initial Utility
The utility derived from the
first unit
of a commodity is called initial
utility. It is always positive.
Total Utility
The total satisfaction derived from the
consumption of all the units of a
commodity.
Consumption of n units of commodity,
then
the total utility (TU)
TUn = U1 + U2 + U3 + .. +Un OR TUn
=Mun
Example:
TU(X) = U(X) = 16 X X2
where X is the amount a good that is
consumed in
a given period of time.
5 units of the product per period of time
yields 55
utils of satisfaction
TOTAL UTILITY
Marginal Utility
The additional satisfaction gained by the
consumption of one more unit of something.
MUn = TUn TUn-1
OR
The change in total utility (TU) resulting
from a one unit change in consumption
(X).
MU = TU/ X
MARGINAL UTILITY
CALCULATION OF MARGINAL
UTILITY
The marginal utility of the 3rd
bottle of water = 36 units
27 units = 9 units.
CALCULATION OF MARGINAL
UTILITY
The marginal utility of
the 3rd bottle of water
= 36 units 27 units =
9 units.
GRAPHICAL PRESENTATION OF TOTAL UTILITY
AND MARGINAL UTILITY
The figure shows total utility
and marginal utility.
Part (a) graphs Tinas total
utility from bottled water.
Each bar shows the extra
total utility she gains from
each additional bottle of
waterher marginal utility.
The blue line is Tinas total
utility curve.
MARGINAL UTILITY
Part (b) shows how Tinas
marginal utility from bottled
water diminishes by placing
the bars shown in part (a)
side by side as a series of
declining steps.
The downward sloping blue line
is Tinas marginal utility curve.
Marginal utility
Positive Marginal Utility
Zero Marginal Utility
Negative Marginal Utility
Positive Marginal Utility
If, by consuming additional units of a
commodity,
total utility increases then the marginal
utilities of
these units will be Positive
Negative Marginal Utility
If the consumption of an additional unit of a
commodity Causes fall in total utility, it
means the
marginal utility of that unit is negative
Zero Marginal Utility
If the consumption of an additional
unit of a
commodity Causes no change in the
total
utility, it means the marginal utility of
that
unit is negative
RELATIONSHIP BETWEEN TOTAL UTILITY AND
MARGINAL
UTILITY
When marginal utility is positive total
utility increases
When marginal utility zero total utility is
at maximum. It is also known as point of
maximum satisfaction
When marginal utility is negative total
utility diminishes.
Total
Utility
Marginal
Utility
Graphs of Total
Utility & Marginal
Utility
is where
marginal utility
TU
X1
X1
reaches its maximum.
This is where we encounter
diminishing marginal utility.
The slope of TU has reached
its maximum; TU has an
inflection point here.
X2
MU
X1
X2
X2 is where total utility
reaches its maximum.
MU is zero.
This is the saturation point
or satiation point.
After that point, TU falls
and MU is negative.
Diminishing Marginal Utility
Each additional unit of a product
contributes
less extra utility than the previous
unit. It is
a psychological fact
Law of Diminishing Marginal
Utility
The law of diminishing marginal utility
explains the relation between utility and
quantity of a commodity.
when a consumer gets more and more
units of a commodity, during a particular
time, the utility from the successive units
will diminish.
Assumptions
1.Utility is cardinal
2.The consumer is rational
3.Constant marginal utility of money
4.The consumers income is limited
and constant
5.The tastes and preferences of the
consumer remain unchanged
6.Diminishing marginal utility
Utility is cardinal
It is assumed that utility can be measured
and
a
consumer
can
express
his
satisfaction in quantitative terms such as
1, 2, 3, etc.
The consumer is rational
The consumer is assumed to be rational
who measures, calculates and compares
the utilities of different commodities and
aims at maximizing total satisfaction.
Constant marginal utility of
money
As a consumer spends money on the
commodity, he is left with lesser money to
spend on other commodities.
In this process, the remaining money becomes
dearer to the consumer and it increases MU of
money for the consumer. But, such an increase
in MU of money is ignored.
As MU of a commodity has to be measured in
monetary terms, it is assumed that MU of
money remains constant.
The consumers income is limited
and constant
It is assumed that income of the consumer
and prices of the goods which the
consumer wishes to purchase remain
constant.
Consumption of reasonable
quantity
It is assumed that a reasonable quantity of
the commodity is consumed.
Continuous consumption
It is assumed that consumption should
be a continuous process.
For example, if one ice-cream is
consumed in the morning and another
in the evening, then the second icecream may provide equal or higher
satisfaction as compared to the first
one.
No change in Quality
Quality of the commodity consumed is
assumed to be uniform.
A second cup of ice-cream with nuts and
toppings may give more.
Independent utilities
It is assumed that all the commodities
consumed
by
a
consumer
are
independent.
It means, MU of one commodity has no
relation with MU of another commodity.
Further, it is also assumed that one
persons utility is not affected by the
utility of any other person.
Consumers Equilibrium A single
commodity
Consumers equilibrium leads to a situation
where
a
consumer
gets
maximum
satisfaction out of his limited income
He has no tendency to make any change in
his existing
expenditure pattern.
The consumer is in equilibrium when the
marginal utility of a good(x) is equal to its
market price (Px).
MUx = Px
The consumer is in equilibrium when
the
marginal utility of a good(x) is equal to
its market price (Px).
MUx = Px
Supposing, if MU P, there can be two
possibilities
1. MU > P
2. MU < P
Law of Equi - Marginal Utility
The law of equi-marginal utility explains the
behaviour of a consumer when he consumes
more
than one commodity.
Further, it explains how the consumer spends
his
limited income on various commodities to get
maximum satisfaction.
Law of Equi - Marginal
Utility
The law states that a consumer maximizes
his
total utility by distributing his entire income
optimally among the various goods
consumed by
him.
ASSUMPTIONS
The consumer is rational so he wants to
get maximum satisfaction
Cardinal measurement of utility is possible
Marginal
constant
utility
of
money
remains
The income of the consumer is given and
remain constant
ASSUMPTIONS
Fashions, tastes and preferences remain
constant
Prices of the commodities are given and
remain constant
Consumption takes place at a given time
period
Consumers Equilibrium a
Several Commodities
When a consumer is consuming several
commodities
[suppose there are two goods X and Y] with
different prices
simultaneously, he will be in equilibrium at
the point
where the utility derived from the last
rupee spent on
each is equal.
The position of consumers
equilibrium thus can be stated in
following ways
The consumer is in equilibrium when the
marginal utility of last rupee spent on
each commodity is equal
A consumer will be in equilibrium
position where the ratios of marginal
utilities of goods to the ratios of
corresponding prices for each pair of
goods are equal.
When a consumer is at
equilibrium
He maximizes his satisfaction
He spends his entire income
He attains optimum allocation of
expenditure
He consumes optimum quantity
of each good
Derivation of the Demand
Curve
If the marginal utility is measured in
monetary units the demand curve for a
good(X) is identical to the positive segment
of the Marginal utility curve.
Constancy of the Marginal
Utility of Money
This
is
one
of
the
important
assumptions of
the marginal utility analysis.
This means, marginal utility of money
remains constant throughout when the
individual is spending money.
Constancy of the Marginal Utility
of Money
Measurement of marginal utility of goods in
terms of money is only possible if the
marginal utility of money itself remains
constant.
If the marginal utility of money varies, it is
not
possible to correct measurement of the
marginal
utility of the good.
Marginal Utility of Money and
Price change
When the price of a good falls the real
income of the consumer rises the
marginal utility of money will fall.
On the other hand, when the price of a
good rises the real income of the
consumer falls the marginal utility of
money will rise.
But Marshall ignored this and assumed that
marginal
utility of money did not change as a result of
price
change. Due to this assumption
Marshall ignored the income effect of the
price change
Marshall could not provide a satisfactory
explanation of Giffen Paradox
Due to this assumption marginal utility
curve becomes the demand curve of the
good.
Demerits of Marginal Utility Analysis
Cardinal measurement is unrealistic
Assumption of constant marginal utility of money is
not valid.
Cardinal utility analysis does not split up the price
effect into substitution and income effect.
Marshall could not explain Giffen Paradox.
Cardinal utility analysis assumes too much and
explains little.
