Introduction
Concept
Who is Consumer ??
A consumer is one who buys goods and services for satisfaction of wants.
Cardinal utility approach
Ordinal utility approach
Concept
Cardinal Utility Approach
Why there’s a Need of the concept Utility??
for example: you have just eaten an ice cream and chocolate can you tell how much are you satisfied from each of these items?
Probably you can tell me which item you like more but it is very difficult to express how much you liked one over the other.
So this is the reason why economists developed the concept of utility..
Concept
Meaning of Utility
It refers to want satisfying power of a commodity.
Concept
how to measure utility??
See according to economist utility can be measured in the same way as weight or height is measured.
so economist assume that utility can be measured in cardinal (numerical )terms so by using cardinal measure of utility it is possible to numerically estimate utility but there was no standard unit for measuring utility. So economists derived an imaginary measure known as Util.
Suppose you have just eaten an ice cream and chocolate now you agree to assign 20 utils as utility derived from the ice cream. now the question is how many utils be assigned to the chocolate ??
if you liked the chocolate less then you may assign utilities less than 20. however if you like it more you would give it a number greater than 20. suppose you assign 10 utils to the chocolate then it means that you liked the ice cream twice as much as you liked the chocolate.
Concept
Satisfaction VS pleasure satisfaction must not be confused with pleasure because satisfaction need not involve actual pleasure for example, treatment of a patient for his broken arm is a source of great satisfaction for the patient. it does not provide him any pleasure as it is merely a relief from pain.
Concept Total utility
It refers to the total satisfaction obtained from the consumption of all possible units of a commodity.
for example. if you are thirsty and the first glass of water gives you satisfaction of 20 utils and the second glass of water gives you 16 Utils. then total utility from two glass of water is 20+16 equal to 36 utils and if third class of water generate satisfaction of 4 utils then total utility from three glass of water will be 20+16+4 equal to 40 utils.
Where N is number of units consumed.
The utility derived from the first unit of a commodity is known as initial utility in our example Utility of 20 utils from the first glass of water total utility is zero at zero level of consumption.
Concept Marginal utility
It is the additional utility derived from the consumption of one more unit of the given commodity.
One more way to calculate the MU
We know Marginal Utility is addition made to total utility by consuming one more unit of a commodity.
It is a change in the TU when one more unit is consumed. But what about when there is. more than one change in units consumed..??
In that case.
MU = Change in Total Utility
Change in no. Of Units
|
Ice-creams Consumed |
Marginal Utility |
Total Utility |
|
1 |
20 |
20 |
|
2 |
16 |
36 |
|
3 |
10 |
46 |
|
4 |
4 |
50 |
|
5 |
0 |
50 |
|
6 |
- 6 |
44 |
Concept Relationship b/w TU & MU.
If we observe the table.
TU is increasing till the point. MU is positive or we can say, where we are getting some utility from each additional unit we are consuming which is upto 4th unit but at a diminishing rate as MU from each successive unit tends to diminish right??
TU is Maximum at point when MU is zero which is at 5th unit consumed this point is known as the point of satiety or the stage of of maximum satisfaction. At this stage TU stops rising.
After consuming this point Of satiety MU is negative and TU starts diminishing. Correct..? And this point is known as Disutility which is opposite of utility. It also refers to the loss of satisfaction due to consumption of too much of a same commodity at the same time.
Example 3. Calculate the missing figures:
Solution:
Explain the question…
Example 2)
Example 1. A person’s total utility (TU) schedule is given below. Derive marginal utility (MU).
Concept Law of diminishing marginal utility (DMU)
It states that as we consume more and more units of a commodity the utility derived from each successive unit goes on decreasing
Let us understand this law with the help of an example.
Suppose your father has just come from work and you offer him a glass of juice the first glass of Juice will give him great satisfaction right?? the satisfaction with the second glass of juice will be relatively lesser with further consumption one stage will come when he would not need any more glass of juice and that stage you know is when the Marginal utility comes to zero after that point if he is forced to consume even one more glass of juice it will lead to this disutility.
So such a decrease in satisfaction with consumption of successive unit occurs due to law of diminishing marginal utility.
Concept
Assumptions of law of diminishing marginal utility.
Cardinal measurement of utility
It is assumed that utility can be measured and consumer can express his satisfaction in numbers like 123 etc.
Monetary measurement of utility
It is assumed that utility can be measure in money that means monetary terms.
Consumption of reasonable quantity
It is assumed that a reasonable quantity or we can say some amount of commodity is consumed.
no he is left with less money to spend on other commodities.
And that remaining money becomes dearer or closer to the consumer and it’s MU means MU of money for the consumer increases but we have to ignore this increase in MU of money we have to focused on MU of a commodity which has to be measured in monetary terms like MU of car in rupees MU of ice cream in rupees don’t focus on MU of Gandhi that means of money.
Fixed-income & prices
It is assumed that income of the consumer and prices of the goods which the consumer wishes to purchase remain constant
Perfect Knowledge
We assume that consumer has perfect knowledge of the various choices available to him.
Concept
Consumer’s Equilibrium
Concept
Consumers equilibrium in case of single commodity
The law of DMU can be used to explain consumers equilibrium in case of single commodity
So all the assumptions of law of DMU are taken as assumption of consumers equilibrium in case of single commodity consumer can express hus satisfaction in numbers in monetary terms he will consume reasonable quantity and that consumption will be continuous and there will be no change in quality he will act as a rational consumer there is a fixed income and prices and consumer has perfect knowledge etcright
A consumer purchasing a single commodity will be at equilibrium, when he is buying such a quantity of that commodity, which gives him maximum satisfaction. The number of units to be consumed of the given commodity by a consumer depends on 2 factors:
1. Price of the given commodity;
2. Expected utility (Marginal utility) from each successive unit.
To determine the equilibrium point, consumer compares the price (or cost) of the given commodity with its utility (satisfaction or benefit). Being a rational consumer, he will be at equilibrium when marginal utility is equal to price paid for the commodity.
We know, marginal utility is expressed in utils and price is expressed in terms of money. However, marginal utility and price can be effectively compared only when both are stated in the same units. Therefore, marginal utility in utils is expressed in terms of money.
Marginal Utility in utils
Marginal Utility in terms of Money Marginal Utility of one rupee (MUM)
MU of one rupee is the extra utility obtained when an additional rupee is spent on other goods. As utility is a subjective concept and differs from person to person, it is assumed that a consumer himself defines the MU of one rupee, in terms of satisfaction from bundle of goods.
Equilibrium Condition
Consumer in consumption of single commodity (say, x) will be at equilibrium when: Marginal Utility (MU) is equal to Price (P) paid for the commodity; i.e. MU₂ = Px
If MU>P, then consumer is not at equilibrium and he goes on buying because benefit is greater than cost. As he buys more, MU falls because of operation of the law of diminishing marginal utility. When MU becomes equal to price, consumer gets the maximum benefits box and is in equilibrium.
• Similarly, when MU,
reduce consumption of commodity x to raise his total satisfaction till MU becomes equal to price.
Note: In addition to condition of "MU= Price", one more condition is needed to attain consumer's equilibrium: "MU falls as consumption increases". If MU does not fall, then consumer will go on consuming the commodity and hence will never attain the equilibrium p osition. However, this second condition is always implied because of operation of Law of DMU.
Let us now determine the consumer's equilibrium if the consumer spends his entire income on single commodity. Suppose, the consumer wants to buy a good (say, x), which is priced at 10 per unit. Further suppose that marginal utility derived from each successive unit (in utils and in ) is determined and is given in Table 2.3 (For sake of simplicity, it is assumed that 1 util = 1, i.e. MUM=1).
Table 2.3: Consumer’s Equilibrium in case of Single Commodity
In Fig. 2.3, MU, curve slopes downwards, indicating that the marginal utility falls with successive consumption of commodity x due to operation of Law of DMU. Price (P) is a horizontal and straight price line as price is fixed at 10 per unit.
From the given schedule and diagram, it is clear that the consumer will be at equilibrium at point 'E', when he consumes 3 units of commodity x, because at point E, MU=Px
• He will not consume 4 units of x as MU of 4 is less than price paid of * 10.
• Similarly, he will not consume 2 units of x as MU of 16 is more than the price paid.
So, it can be concluded that a consumer in consumption of single commodity (say, x) will be at equilibrium when marginal utility from the commodity (MU) is equal to price (P) paid
For the commodity. The equilibrium condition can also be expressed as:
MUx / Mum = Px or. MUx / Px. = Mum
Example 4. Suppose the price of a commodity ‘x’ is given as ₹ 8 and the MU (in terms of money) for 4 units is given as:
Consumer will purchase 3 units because at 3rd unit, MU = Price
Example 5. Given below is the utility schedule of a consumer for commodity X. The price of the commodity is ₹ 6 per unit. How many units should the consumer purchase to maximize his satisfaction? (Assume that utility is expressed in utils and 1 util = ₹ 1). Give reasons for your answer.
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Solution:
Consumer will purchase 4 units because at 4th unit, MU = Price.
Example 6. Following is the utility schedule of a person:
Suppose that the commodity is sold for ₹ 4 and MU of one rupee is 5 utils. How many units of the commodity will the person purchase to maximise his satisfaction?
Solution:
Let us first calculate MU in terms of money (MUx).
Consumer will purchase 4 units because at 4th unit, MU = Price.
Example 7. Suppose that an ice-cream is sold for ₹30. Laxmi, who loves ice-cream, has already eaten 3. Here Marginal utility from eating the 3rd ice-cream is 90 utils. If MU of ₹ 1 is 3 utils, should she eat more ice-creams or should she stop?
Solution:
Given: Price (PIC) = ₹ 30; Marginal utility from eating 3rd ice-cream = 90 utils. Value of 3 utils = ₹ 1, i.e. MUM = 3.
MU in terms of Money 
Laxmi should not consume any more ice-creams as the condition for consumer equilibrium “MUIC = PIC” is satisfied at 3rd ice-cream.
Concept
Consumer’s Equilibrium in case of Two Commodities
The Law of DMU applies in case of either one commodity or one use of a commodity.
However, in real life, a consumer normally consumes more than one commodity.
In such a situation, Law of Equi-Marginal Utility’ helps in optimum allocation of his income.
Law of Equi-marginal utility is also known as:
(i) Law of Substitution;
(ii) Law of maximum satisfaction;
(iii) Gossen’s Second Law.
As law of Equi-marginal utility is based on Law of DMU, all assumptions of the latter also applies to the former.
Let us now discuss equilibrium of consumer by taking two goods: ‘x’ and ‘y’.
In case of consumer equilibrium under single commodity, we assumed that the entire income was spent on a single commodity.
Now, consumer wants to allocate his money income between the two goods to attain the equilibrium position.
According to the law of Equi-marginal utility,
a consumer gets maximum satisfaction, when ratios of MU of two commodities and their respective prices are equal and MU falls as consumption increases.
It means, there are two necessary conditions to attain Consumer’s Equilibrium in case Of Two Commodities:
The ratio of Marginal Utility to Price is same in case of both the goods.
• We know, a consumer in consumption of single commodity (say, x) is at equilibrium
When MUx (₹) = Px… or MUx/Px =1
• Similarly, consumer consuming another commodity (say, y) will be at equilibrium
MUy (₹) = Py or MUy/Py =1
Equating 1 and 2, we get:
MUx/Px = MUy/Py = MUm ( Marginal utility of one rupee) if we cross interchange..
We can also say or write
MUx/ MUy = Px/Py
ii) MU falls as consumption increases:
The second condition needed to attain consumer's equilibrium is that MU of a commodity must fall as more of it is consumed.
If MU does not fall as consumption increases, the consumer will end up buying only one good which is unrealistic and consumer will never reach the equilibrium position.
Finally, it can be concluded that …a consumer in consumption of two commodities will be at equilibrium when he spends his limited income in such a way
that the ratios of marginal utilities of two commodities and their respective prices are equal and MU falls as consumption increases.
What happens when
MUx/ Px not equal to MUy/Py.
Suppose, MUx/Px > MUy/ Py
In this case, the consumer is getting more marginal utility in case of good X ..as compared to Y…
Therefore, he will buy more of X and less of Y…
This will lead to fall in MUx and rise in MUy.
The consumer will continue to buy more of X till MUx/ Px = MUy/Py
Now Suppose, MUx/Px < MUy>
the consumer is getting more marginal utility per rupee in case of good Y as compared to X.
Therefore, he will buy more of Y and less of X.
This will lead to fall in MUy and rise in MUx.
The consumer will continue to buy more of Y till MUx/ Px = MUy/Py
It brings us to a conclusion that MUx / Px = MUy/Py is a necessary condition to attain Consumer's Equilibrium.
Diagrammatic explanation
Table 2.4: Consumer’s Equilibrium in case of Two Commodities
It is obvious that the consumer will spend the first rupee on commodity 'x', which will provide him utility of 20 utils. The second rupee will be spent on commodity 'y' to get utility of 16 utils and so on.. right??
But. To reach the equilibrium, consumer should purchase that combination of both the goods, when:
MU of last rupee spent on each commodity (X&Y) is same; and
i.e. MUx/ Px = MUy/Py
(ii) MU falls as consumption increases.
It happens at when consumer buys 3 units of 'x' and 2 units of 'y' because:
• MU from last rupee (i.e. 5th rupee) spent on commodity y …gives the same satisfaction of 12 utils… as given by last rupee (i.e. 4th rupee) spent on commodity x; [ show in table & explain]. and
• MU of each commodity also falling as the consumer is increasing the consumption ight?
The total satisfaction of 74 utils (20 + 16 + 14 + 12 + 12) will be obtained when consumer buys 3 units of 'x' and 2 units of 'y'.
It reflects the state of consumer's equilibrium. ..
If the consumer spends his income in any other order, total satisfaction will be less than 74 utils...
Or ese multiple combinations you’ll find, total satisfaction will be less than 74 utils.
Concept Limitation of Utility Analysis
In the utility analysis, it is assumed that utility is cardinally measurable, i.e., it can be expressed in exact unit. However, utility is a feeling of mind and there cannot be a standard measure of what a person feels. So, utility cannot be expressed in figures. There are other limitations too. But, their discussion is beyond the scope.
Concept
Practicals on consumer’s equilibrium (Two commodities).
Q1
The marginal utility schedule for goods X & Y are given below both the goods are priced at Rs.1 each and income of Mohan (an individual )is assumed to be Rs.8 determine how many units of both the commodities should be purchased by Mohan to maximise his total utility?
Q2 A consumer consumes only two goods X and Y whose prices are Rs.5 in Rs.4 per unit respectively. if MUy = 16 at the point of consumer’s equilibrium, calculate MUx.
MUx/5 = 4
MUx= 5*4 = 20
Q4:- A consumer consumes only two goods X & Y whose prices are Rs.5 and Rs.6 per unit respectively.
If the consumer chooses a combination of the two goods with marginal utility of X equal to 35 and that of Y equal to 30, is the consumer in equilibrium?? give reasons what will a rational consumer do in this situation?? use utility analysis.
Concept
ORDINAL UTILITY APPROACH (INDIFFERENCE CURVE OR HICKSIAN ANALYSIS)
The real elaboration of the Indifference Curves was made by J. R. Hicks and R. G. D. Allen, Popularly known as Hicks and Allen. In 1934, they wrote an article, ‘A Reconstruction of the Theory of Value’, presenting the Indifference Curve Analysis.
Modern economists disregarded the concept of ‘cardinal measure of utility’. They were of the opinion that utility is a psychological phenomenon and it is next to impossible to measure the utility in absolute terms.
According to them, a consumer can rank various combinations of goods and services in order of his preference.
For example, if a consumer consumes two goods, Apples and Bananas, then he can indicate:
1. Whether he prefers apple over banana; or
2. Whether he prefers banana over apple; or
3. Whether he is indifferent between apples and bananas, i.e. both are equally preferable and both of them give him same level of satisfaction.
This approach does not use cardinal values like 1, 2, 3, 4, etc.
Rather, it makes use of ordinal numbers like 1st, 2nd, 3rd, 4th, etc. which can be used only for ranking.
It means, if the consumer likes apple more than banana, then he will give 1st rank to apple and 2nd rank to banana.
Such a method of ranking the preferences is known as ‘ordinal utility approach’.
Ordinal utility is the utility expressed in ranks.
Before we proceed to determine the consumer’s equilibrium through this approach, let us understand some useful concepts related to Indifference Curve Analysis.
Concept
Meaning of Indifference Curve
When a consumer consumes various goods and services, then there are some combinations, which give him exactly the same total satisfaction.
The graphical representation of such combinations is termed as indifference curve.
Indifference curve refers to the graphical representation of various alternative combinations of bundles of two goods among which the consumer is indifferent.
Let us understand this with the help of following indifference schedule, which shows all the combinations giving equal satisfaction to the consumer.
As seen in the schedule, consumer is indifferent between five combinations of apple and banana. Combination 'P' (IA + 15B) gives the same utility as (2A + 10B), (3A + 6B) and so on. When these combinations are represented graphically and joined together, we get an indifference curve 'IC' as shown in Fig.
In the diagram, apples are measured along the X-axis and bananas on the Y-axis. All points (P, Q, R, S and T) on the curve show different combinations of apples and bananas. These points are joined with the help of a smooth curve, known as indifference curve (IC₁). An indifference curve is the locus of all the points, representing different combinations, that are equally satisfactory to the consumer.
Every point on IC, represents an equal amount of satisfaction to the consumer. So, the consumer is said to be indifferent between the combinations located on Indifference Curve IC₁'.
The combinations P, Q, R, S and T give equal satisfaction to the consumer and therefore he is indifferent among them. These combinations are together known as 'Indifference Set'.
Concept
Monotonic Preferences
Monotonic preference means that a rational consumer always prefers more of a commodity as it offers him a higher level of satisfaction.
In simple words, monotonic preferences implies that as consumption increases total utility also increases.
For instance, a consumer's preferences are monotonic only when
between any two bundles, he prefers the bundle which has more of at least one of the goods and no less of the other good as compared to the other bundle.
Example: Consider 2 goods: Apples (A) and Bananas (B).
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