Utility

UTILITY DEWETT PAGE NOS 65/73&38/39

UTILITY -Definition • Human wants are satisfied with “GOODS". This want satisfying quality in a good is called UTILITY. • Utility means the power to satisfy a human want

Utility. • To find whether good possess utility or not ask the following question • Does it satisfy human want? • If yes, it has utility-otherwise NO • If you are prepared to pay for it, it is clear that it will satisfy his want. For him the commodity will possess utility • Eg-air, water etc (free goods) • Food, clothing ( economic goods)

Utility& Usefulness Distinguished

• The term “utility” in Economics has no ethical or moral significance. A thing may be good or bad, if it satisfies human want it shall possess utility. • Opium-injurious to health and poisonous • A vulgar picture • If people are prepared to pay and satisfy their wants, they possess utility.

Utility does not mean satisfaction

• Satisfaction is what we get and utility is the quality in the thing which gives satisfaction. • Mango gives utility is incorrect. we should say it possess utility or it gives satisfaction. A thing possess utility but it gives satisfaction

Utility is subjective • Blind man cannot see picture. No utility for him. • Cigarette – no utility for a non smoker • Varies from individual to individual. It is consumer's mind which gives its utility

Different utility at different time for same commodity • A warm suit has greater utility in winter than in summer • A rain coat has greater utility during rain.

The same product may possess different utility for different purposes • Water has different utilities when used for drinking, bathing, washing or irrigation.

Form and utility • A log of wood – less utility • Table - more utility

Change of ownership and utility • When a cultivator buys land from a non cultivating owner, utility increases • When a rich man deposits his idle money in a bank, it can be loaned out to some one in need of it.

Forms of utility • (a) FOAM UTILITY • By changing the of an article, we can give it greater utility • ie transforming a log of wood in to a piece of furniture

(b) Place of utility • Utility can be increased by transporting a good from one place to another. • When timber is brought to the market, it comes to have much greater utility than it had in forest

(c). Time utility • By storing a commodity and selling at the time of scarcity we can give it greater utility

Utility analysis of demand • A very important law in consumption relates to the fact that as we go on consuming a commodity, the satisfaction derived from its successive units go on decreasing. • As we go on consuming a particular commodity, each successive units of the commodity yields him less and less satisfaction • In other words, at each step its utility (marginal utility, not total utility) goes on decreasing.

• Dr Marshall states the law thus:• “ The additional benefit which a person derives from a given increase of his stock of anything diminishes with growth of stock he has”

No of appl es

Margin Total al utility utility

1 2 3 4 5 6 7 8 9

15 13 10 8 4 2 0 -2 -5

15 28 38 46 50 52 52 50 45

• As the consumer goes on eating apples, the additional or marginal utility goes on decreasing. The 7th apple yields no additional satisfaction and 8th and 9th have negative utility. • But total utility goes on increasing up to a point, but only at a diminishing rate.

Diagrammatic representation •

Y

B U

D D F

M U

H LL L

N 89

O

1A 2C 3E 4G 5K 6M 7 Units of commodity

UI

X

• OX & OY are 2 axes • OX represents commodity –apples • OY –represents MU • U-U1-Utility curve • AB- utility curve when one apple is taken • CD- when 2 apples taken but it is less than AB • The additional utilities of successive apples are EF,GH, KL, MN etc • At 7 it is zero-no addition • After 7, MU is negative

INITIAL-TOTAL-ZERONEGATIVE UTILITY • INITIAL UTILITY • It is the utility of the initial or the first unit. In the given table , initial utility is 15

Total utility • It gives the total utility at each step • If you consume one apple, the total utility is 15. if you consume two, the total utility is 28 and so on

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 at 6 is 52, at 7th also 52- at 7th no increase whatsoever. This is the point of zero utility. It is thus seen that total utility is maximum when marginal utility is Zero

Negative utility • If the consumption of a commodity is carried to excess, thus instead of giving any satisfaction, it may cause dissatisfaction. • The utility in such a case is negative. In the table given above, the marginal utility of 8th and 9th units are negative.

Limitations or Exceptions • The law of diminishing utility says that as we go on consuming more and more units of a commodity, the utility falls with every successive unit consumed. But this is not true in all cases. We can see limitations

(1) DISSIMILAR UNITS • If the unit is not identical, the law will not apply. • For eg, the second apple is much larger than the first one, it will yield more satisfaction than the first. The law will apply only if units are similar

(2) VERY SMALL UNITS • If we are thirsty, if water is given by a small spoon, then each successive spoonful will give more satisfaction • If it is in a tumbler, the law starts working at once • In the case of small units, MU will increase instead of decreasing. But if the consumption is continued, MU must fall and this is what law states.

(3) TOO LONG INTERVAL • Suppose you take morning meal at 10 am and dinner at 8 pm and you eat nothing in between, the dinner will give greater satisfaction than your breakfast. • If you are taking another meal within an hour of first, the law applies. • The law therefore applies only the units of the commodity are falling quickly one after the other within a reasonable period of time.

(4) RARE COLLECTION • The law does not apply in the case of rare collection • Rare coins, stamps

(5) ABNORMAL PERSONS • The law talks about normal person • But there are abnormal persons also. Eg miser • The more money he has, the greater is the satisfaction

(6) Change in another person’s stock • Suppose there are 2 persons collecting stamps in a town and both are rivals. • Suppose that by accident, the stock of one of them is destroyed. • Automatically, the value of stock of other person will go up even though there has been no change in his stock

(7) Change in income, habits and taste • A change in consumer’s income, a change in fashion and a change in other possessions of the consumer also seem to upset the law of Diminishing Marginal Utility. In such cases increase in consumption may yield greater and greater satisfaction.

Does the law of Diminishing Marginal Utility apply to Money?

• It is said that the law of Diminishing Marginal Utility could not apply to money. • More money will be welcomed even if a person has much of it • But little thought will show that even money is no exception to this law. As man grows rich, he becomes careless in spending money and wastes it on useless luxuries which do him no good. The marginal utility decreases. That is why govt taxes the rich people. The richer they are, higher taxes. Hence law of Diminishing Marginal Utility applies to Money

Marginal utility (Relation between MU TU MU & TU)

UNITS OF APPLE

1

2 3 4 5 6 7 8 9

15 13 10 8 4 2 0 -2 -5

15 28 38 46 50 52 52 50 45

• MU is the addition made to total utility by having an additional unit of the commodity. The total utility of 2 apples is 28, of three 38 (15+13+10). Thus MU of third apple is 38-28=10. • MU of a commodity is the loss in unit if one unit is less consumed. The MU of n units is the total unit (TU) of n units minus the total utility of n-1

Marginal utility and price • In the previous table, column 2 gives marginal utilities. Suppose each unit of MU is worth 10 paise. This would mean that utility of 1ST apple is 15 ten paise.suppose Apple is sold at 80 paise eah. Then we will stop buying at 4th because at this point MU and price have been equated. • At the 3rd the utility is worth Re 1/= where price is 80 paise. Hence we are tempted to buy the next, ie the 4th . But no more. at this point the price is 80 paise and utility is also 80 paise. The two coincides • If the price of apple were to fall to 20 paise each , we will buy even the 6th for it where MU and price will be equal. • Thus when we pay for a certain price for a commodity, it can be taken for granted that satisfaction is at least equal to the price paid.

Importance of law of DMU • IN TAXATION (progressive taxation is based on this law) • IN DETERMINING MARKET PRICE (he can be induced to buy more if the price is lowered) • IN SUPPORT OF SOCIALISM ( beyond certain point wealth is not having any utility for rich man. If transferred to poor it will have greater utility) • IN HOSEHOLD EXPENDITURE (we stop purchasing at a point when utility of money spent is equal to to the utility of last unit of commodity purchased. Spend the rest of the money on other commodities) • BASIS ON OTHER ECONOMIC LAWS ( law of Demand, consumer’s surplus, elasticity of demand, law of substitution)

Law of equimarginal utility • This law of equimarginal utility is also known as LAW OF SUBSTITUTION or LAW OF MAXIMUM SATISFACTION

Law of equimarginal utility • The human wants are unlimited where as means to buy these wants are strictly limited. • It , therefore, becomes necessary to pick the most urgent wants that can be satisfied with money. • He decides to buy the right quantity by making the best use of money at his disposal and derive maximum satisfaction.

Explanation of law of equimarginal utility • To get maximum satisfaction out of funds we have, we carefully weigh the satisfaction obtained from each rupee that we spend. • When we buy 2 commodities of different utilities, we ensure that MU of both are equalized by substituting one product with other. That is why the law is also called the law of substitution or law of equimarginal utility

Explanation of law of equimarginal utility • Suppose we have Rs 7/= with us and want to buy apples and oranges • Let us say that we spend Rs 3/on orange and Rs 4/- on apple and the price of both is Re 1/- each

unit

MUorange

MUapple

1 2 3 4 5 6 7 8

10 8 6 4 2 0 -2 -4

8 6 4 2 0 -2 -4 -6

Explanation of law of equimarginal utility unit MU- MU-

• Rs 3/- (orange) • Rs 4/- (apple) • As the MU of 3rd orange is higher, we should buy more orange and less apple. • Let us substitute one orange for one apple. Now MU of both orange and apple is same ie 4. this arrangement gives max satisfaction.

1 2 3 4 5 6 7 8

orange

apple

10 8 6 4 2 0 -2 -4

8 6 4 2 0 -2 -4 -6

Explanation of law of equimarginal utility unit MU-

• The total utility of orange would be 10+8+6+4=28 and 3 apples 8+6+4=18 which gives a total utility of 46. • No other combination can give you a greater satisfaction than this

MUorange apple

1 2 3 4 5 6 7 8

10 8 6 4 2 0 -2 -4

8 6 4 2 0 -2 -4 -6

DIAGRAMATIC REPRESENTATION y

y

APPLE

M U

M U

L

4

4

1

ORANGE

o

P

E

M 3

N 4

UNITS OF MONEY

x

P’

N’

1 0

M’ 3

4

UNITS OF MONEY

x

• • • •

In the two figures OX and OY are 2 axis X axis – units of money Y axis – marginal utility The consumer will get max satisfaction if he spends OM money (Rs3/-) on apples OM’ money (Rs 4/-) on oranges because in this situation the MU of both are equal. • PM = P’M’ • Let the purchaser spends spend MN money (Re1/-) on apples and the same amount of money less on orange.

• The diagram shows a loss of utility represented by shaded area asLN’M’P’ and a gain of PMNE utility. • Loss of utility from reduced consumption of orange is bigger than the gain of utility due to the increased consumption of apple. As MN=M’N’ and PM =P’M’, it is proved that area LN’M’P’ is bigger than PMNE. Hence the total utility of new consumption is less.