Utility - Concept and Types - Law of Diminishing Marginal Utility - Assumptions and Limitations

Utility - Concept and Types - Law of Diminishing Marginal Utility - Assumptions and Limitations

1. Prepared By: Mohammed Jasir PV Asst. Professor MIIMS, Puthanangadi Contact: [phone]

2. Topics / Area Utility Concept and types of utility Law of Diminishing Marginal Utility Assumption and limitation of LDMU

3. UTILITY

4. Utility Can be defined as want satisfying capacity of a product. Level of satisfaction

5. Utility Classification Cardinal utility Ordinal utility Total utility Marginal Utility

6. Cardinal Utility It assume that utility is measurable or quantifiable that is it can be measured in some units. According to this approach , how much utility a consumer obtains from goods can be expressed in cardinal numbers such as 1,2,3 and so forth. It is expressed as a quantity measured in units which are called utils . Example: It can be said that an apple has 10 utils and mango has 5 utils.It implies that utility of apple is twice that of a mango.

7. Ordinal Utility Ordinal utility approach is purely subjective and is immeasurable. Preferences among goods can be ranked using ordinal numbers such as first, second , third etc. Utility from one source may be ‘equal to’ ’more than’ or ‘less than’ utility from another source. But it is not possible to state the difference in absolute or numeric units.

8. Total utility & Marginal utility Total utility: It is the sum total of utilities of all units of a commodity consumed at a particular time It is the utility of the entire commodity Marginal utility : is the change in total utility on account of one additional unit utilized Marginal Utility= TUn - TUn-1

9. Law of Diminishing Marginal Utility

10. Law of Diminishing Marginal Utility The law states that marginal utility of a commodity diminishes as an individual consume more and more of the commodity. That is, as we consume more and more of commodity the utility derived from the addition unit diminishes.

11. Contd.. The law states that as the stock of commodity increases with the consumer, its marginal utility to the consumer decreases . It can eventually fall to zero and become even negative . If consumption keeps on increasing, marginal utility actually become negative, negative marginal utility means disutility - the product become bad, no good.

12. The following table shows the total and marginal utilities derived by a person from the consumption of oranges The table shows that as the consumption of oranges increases marginal utility falls. That is, total utility is increasing at a diminishing rate. However, when number of oranges consumed increases to seven, marginal utility becomes negative and total utility starts declining

13. Law of Diminishing Marginal Utility

14. Assumptions in Law of Diminishing Marginal Utility The utility is measurable(cardinal Homogenous unit Size Consumption is normal Continuous Consumption Type of commodity is used for consumption at a time Rational human being and aims at maximum satisfaction

15. Assumptions in Law of Diminishing Marginal Utility The utility is measurable(cardinal ) All the units of the given commodity are homogenous that is identical in size, shape, quantity , quality etc The unit of consumption are of reasonable size The consumption is normal The consumption is continuous The law assumes that only one type of commodity is used for consumption at a time The consumer is rational human being and aims at maximum satisfaction

16. Applications of the Law of DMU The law of diminishing marginal utility is the basic law of consumption. The law of demand and law of equi -marginal utility are based on it. The law explains the basis of price fixation in the market and validates what is called ‘ water-Diamond paradox ’. why water is priced lesser than diamond even if it is a luxury good? Due to its scarcity, diamond possesses high MU and hence the higher price whereas water is relatively abundant having lesser MU and hence the lower price. The law helps to explain the phenomenon that the price of a commodity falls when its supply increases . It is because with the increase in the stock of commodity ,its marginal utility diminishes. In this way prices are determined.

17. Contd … The law of DMU serves as the basis for progressive taxation . The MU of money for a poor person is higher than that for a rich person, because poor person possesses little money; therefore the utility derived from each unit of money is huge. This implies that rich people are able to pay more as taxes than poor people. Thus concept leads to progressive taxation system, which imposes heavier tax burden on the rich.

18. Limitation of law of DMU Rare collection (Coins and stamps) and Precious good. Money (Never falls to zero) If a dress comes in fashion , its utility goes up. The law of DMU does not apply in the initial stage. All units of the commodity should be homogeneous units. Example, the first apple is sour and the second sweet, the second will give greater satisfaction.

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