utility analysis (Unit 1) POST GRADUATE.pptx

HELPING TO PROVIDE STUDY

1. 1

2. Utility  is a term in  economics refers to the total satisfaction received from consuming a good or service. In the words of Hibbdon , “Utility is the Quality of a good to satisfy a want.” Thus we can say that wants satisfying power of a commodity is called utility 2

3. UTILITY IS SUBJECTI VE : It is subjective because it deals with the mental satisfaction of a man. UTILITY IS RELATI VE : It varies from person to person and from time to time or place to place for the same individual E.g. Cooler has utility in the summer but not during winter . UTILITY IS NOT ESSENTIALLY USEFUL :A commodity having utility need not be useful. Liquor and cigarette are not useful, but to satisfy the want of an addict then they gave utility for him. 3

4. UTILITY IS ABSTRACT - It is abstract in a sense as it cannot be seen or touched or felt. For example, teaching of a teacher, advice of a lawyer. UTILITY AND PLEASURE - It is not necessary that a commodity possessing utility also gives pleasure whenever it is consumed. An injection possesses utility to an individual. However, it gives him/her physical pain. Hence, utility and pleasure are unrelated. UTILITY IS INDEPENDENT OF MORALITY: Utility has nothing to do with morality.

5. Forms of Utility: Time Utility: These are created by making things available when they are required. Utility of a commodity changes from time to time. For example’ an umbrella has immense utility in rainy season, but has no utility or relative less utility during winter time. Form Utility: Utility of a commodity changes with the change in shape, size and formation. For instance, a piece of timber wood has very less utility for an individual, but its utility increases when is transformed into nice looking furniture.

6. Place Utility: It is added to a commodity by transporting it from the place where it is plenty to the place where it is scarce. For example, utility of coal increases when it is transported from coal mines to open market. Traders and merchants create place utility. Possession Utility: When the change in possession of a commodity increases utility, then it is known as possession utility. The utility of a hammer is not so high for producers as it is for the carpenter (transaction).

7. Types of Utility : It is basically of three types Total Utility The sum of the total satisfaction from the consumption of specific goods or services. It increases as more goods are consumed. Total Utility (T.U.) = U1 + U2 + … + Un

8. 2. Marginal Utility : It is the additional satisfaction gained from each extra unit of consumption. It decreases with each additional increase in the consumption of a good. Marginal Utility (M.U.) = Change in T.U. / Change in Total Quantity = Δ TU/ Δ Q Marginal utility can be: ( i ) positive (ii) zero (iii) negative.

9. 3. Average Utility : One can obtain it by dividing the total unit of consumption by the number of total units. Suppose there are total n units, then Average Utility (A.U.) = T.U. / Number of units = T.U. / n

10. Cardinal Utility Approach UTILITY APPROACH Ordinal Utility Approach

11. Cardinal Utility Approach The cardinal utility theory was developed by the neo-classical economists, viz , Gossen of Germany, William Stanley Jevons of England, Leon Walras of France and Karl Menger of Austria. Alfred Marshal made significant refinements in the cardinal utility theory. In this background, the cardinal utility theory is also called the Marshallian theory , Neo – classical Utility Analysis , and so on. Marshall provides a cardinal measurement of utility. Higher the price paid buy a consumer for a commodity, higher shall be it’s utility and vice versa. Price can be a measure of the utility of a commodity . In this way, a consumer is assumed to be capable of assigning to every commodity a number representing the amount of utility associate with it.

12. Assumptions of Cardinal Utility Approach The consumer is rational being. Consumer possess perfect knowledge of the price in the market. The choices of the goods are certain in the market. The prices of various commodities are not influence by variations in their supply. There are no substitutes and that the utilities are measurable in terms of money.

13. The Ordinal Utility approach is based on the fact that the utility of a commodity cannot be measured in absolute quantity, but however, it will be possible for a consumer to tell subjectively whether the commodity derives more or less or equal satisfaction when compared to another. The modern economist, Hicks, in particular, have applied the ordinal utility concept to study the consumer behavior. He introduced a tool of analysis called  “Indifference Curve”  to analyze the consumer behavior. Ordinal Utility approach

14. Assumptions of Ordinal Utility approach Rational behaviour of the consumer. Utility is ordinal. Consistency in choice. Consumer’s preference is based on Indifference Curve Analysis.

15. 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. Difference between Ordinal and Cardinal Utility

16. 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 .

17. 9

18. It states that as the consumer goes on consuming more and more amount of commodity the marginal utility of the commodity goes on declining becomes zero and finally becomes negative. E.g. If you are having glass of water at given time, then as the number o f glasses of water goes on increasing, the marginal utility from each successive glass of water will go on decreasing. 18

19. Consumer is rational. Utility can be measures in the cardinal number system. Marginal utility of every commodity is independent. Various units of the goods are homogeneous. There is a continuous (no time gap) consumption of the commodity. Suitable quantity of the commodity is consumed. There is no change in the tastes, character, fashion and habits of consumer. 19

20. No. of ice cream cups Marginal Utility First 4 Second 3 Third 2 Fourth 1 Fifth Sixth -1 20 TABLE SHOWING LAW OF DIMINISHING MARGINAL UTILITY

21. It is evident from the table and diagram that first cup of ice cream yield 4 utils thus higher satisfaction and with consumption of more and more units of ice cream, MU from each successive unit goes on diminishing. O 1 2 3 4 5 6 21 3 2 1 -1 B A 4 +ve Y -ve X C QUANTITY UTILITY M.U. CURtfE Zero M. U .

22. Law of Equi – Marginal Utility It states that consumer will distribute his income between the goods in such a way that utility derived from last rupee spent on each good is equal. In other words : The law of equi -marginal utility explains the behavior of the consumer when he spends his limited income on various commodities and services. Every consumer will allocate his resources on various items in such a way as to secure the maximum satisfaction. The  equi -marginal  principle states that consumers will choose a combination of goods to maximise their total  utility . This will occur where, the consumer will consider both the  marginal utility  MU of goods and the price. In effect, the consumer is evaluating the MU/price.

23. Quantity MUx (Mango) MUy (apple) 1 100 35 2 90 30 3 80 25 4 70 20 5 60 15 6 50 10 RS – 75 (X) Mango = Rs. 10 per kg (Y) Apple = Rs. 5 per Kg MUx /Px = MUy / Py

24. Quantity MUx/Px MUy/Py 1 10 7 2 9 6 3 8 5 4 7 4 5 6 3 6 5 2 4 * 10 = 40 , 1 * 5 = 5 { 45 } 5* 10 = 50 , 2 * 5 = 10 { 60 } 6 * 10 = 60 , 3 * 5 = 15 { 75 } (BEST)

25. Indifference curve analysis An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. Graphically , the indifference curve is drawn as a downward sloping convex to the origin. The graph shows a combination of two goods that the consumer consumes.

26. a combination of tw .  

27. 27

28. Total utility is increasing at increasing rate so long as marginal utility is positive. Total utility becomes maximum when marginal utility is zero. Total utility starts declining when marginal utility is negative. TU=TOTAL UTILITY MU=MARGINAL UTILITY 28

29. UNTIS TOTAL UTILITY MARGINAL UTILITY 1 8 8 2 14 6 3 18 4 4 20 2 5 20 6 18 -2 7

30. TU is maximum Saturation point TU Y X Y X MU +ve MU = MU (–)ve MU 8

31. 31