Assignment Submission

For

Paper No. & Subject Name: Harshil Chauhan

Topic: Discuss the concept of Utility. Explain consumer

surplus

Semester: 1

Roll No.: 42

Academic Year: 2022-2023

Submitted To,

LJ School of Law

Signature of Student:
Signature of Faculty:
 What Is Utility?

In economics, utility is a term used to determine the worth or value of a good or service. More
specifically, utility is the total satisfaction or benefit derived from consuming a good or service.
Economic theories based on rational choice usually assume that consumers will strive to
maximize their utility.
The economic utility of a good or service is important to understand because it directly
influences the demand, and therefore price, of that good or service. In practice, a consumer's
utility is usually impossible to measure or quantify. However, some economists believe that they
can indirectly estimate what is the utility of an economic good or service by employing various
models.

KEY TAKEAWAYS
 Utility, in economics, refers to the usefulness or enjoyment a consumer can get from a
service or good.
 Although the concept of utility is abstract, it is a useful way to explain how and why
consumers make their decisions.
 "Ordinal" utility refers to the concept of one good being more useful or desirable than
another.
 "Cardinal" utility is the idea of measuring economic value through imaginary units,
known as "utils."
 Marginal utility is the utility gained by consuming an additional unit of a service or good.

Understanding Utility
The utility definition in economics is derived from the concept of usefulness. An economic good
yields utility to the extent to which it's useful for satisfying a consumer’s want or need. Various
schools of thought differ as to how to model economic utility and measure the usefulness of a
good or service.
Utility in economics was first coined by the noted 18th-century Swiss mathematician Daniel
Bernoulli. Since then, economic theory has progressed, leading to various types of economic
utility.
Ordinal Utility
Early economists of the Spanish Scholastic tradition of the 1300s and 1400s described the
economic value of goods as deriving directly from this property of usefulness and based their
theories on prices and monetary exchanges.
This conception of utility was not quantified, but a qualitative property of an economic good.
Later economists, particularly those of the Austrian School, developed this idea into an ordinal
theory of utility, or the idea that individuals could order or rank the usefulness of various discrete
units of economic goods.
Austrian economist Carl Menger, in a discovery known as the marginal revolution, used this type
of framework to help him resolve the diamond-water paradox that had vexed many previous
economists. Because the first available units of any economic good will be put to the most highly
valued uses, and subsequent units go to lower-valued uses, this ordinal theory of utility is useful
for explaining the law of diminishing marginal utility and fundamental economic laws of supply
and demand.

Cardinal Utility
To Bernoulli and other economists, utility is modeled as a quantifiable or cardinal property of the
economic goods that a person consumes. To help with this quantitative measurement of
satisfaction, economists assume a unit known as a “util” to represent the amount of
psychological satisfaction a specific good or service generates for a subset of people in various
situations. The concept of a measurable util makes it possible to treat economic theory and
relationships using mathematical symbols and calculations.
However, it separates the theory of economic utility from actual observation and experience,
since “utils” cannot actually be observed, measured, or compared between different economic
goods or between individuals.
If, for example, an individual judges that a piece of pizza will yield 10 utils and that a bowl of
pasta will yield 12 utils, that individual will know that eating the pasta will be more satisfying.
For the producers of pizza and pasta, knowing that the average bowl of pasta will yield two
additional utils will help them price pasta slightly higher than pizza.
Additionally, utils can decrease as the number of products or services consumed increases. The
first slice of pizza may yield 10 utils, but as more pizza is consumed, the utils may decrease as
people become full. This process will help consumers understand how to maximize their utility
by allocating their money between multiple types of goods and services as well as help
companies understand how to structure tiered pricing.
Total Utility
If utility in economics is cardinal and measurable, the total utility (TU) is defined as the sum of
the satisfaction that a person can receive from the consumption of all units of a specific product
or service. Using the example above, if a person can only consume three slices of pizza and the
first slice of pizza consumed yields ten utils, the second slice of pizza consumed yields eight
utils, and the third slice yields two utils, the total utility of pizza would be twenty utils.

Marginal Utility
Marginal utility (MU) is defined as the additional (cardinal) utility gained from the consumption
of one additional unit of a good or service or the additional (ordinal) use that a person has for an
additional unit.
Using the same example, if the economic utility of the first slice of pizza is ten utils and the
utility of the second slice is eight utils, the MU of eating the second slice is eight utils. If the
utility of a third slice is two utils, the MU of eating that third slice is two utils.
In ordinal utility terms, a person might eat the first slice of pizza, share the second slice with
their roommate, save the third slice for breakfast, and use the fourth slice as a doorstop.

How Do You Measure Economic Utility?

While there is no direct way to measure the utility of a certain good for an individual consumer,
it is possible to estimate utility through indirect observation. For example, if a consumer is
willing to spend $1 for a bottle of water but not $1.50, economists can safely state that a bottle of
water has economic utility somewhere between $1 and $1.50. However, this becomes difficult in
practice because of the number of variables that are present in a typical consumer's choices .

What Are the 4 Types of Economic Utility?

In behavioral economics, the four types of economic utility are form utility, time utility, place
utility, and possession utility. These terms refer to the psychological importance attached to
different forms of utility. For example, form utility is the result of the design of a product or
service, and time utility refers to the ability of a company to provide services when the customers
need them.
How Do You Invest in Utilities?
Utilities are companies that operate in the electric, water, oil, or gas sectors. These companies
play a major role in industrial economies and have a total market capitalization of nearly $1.6
trillion. In addition to investing in individual companies, there are also many targeted funds that
are invested in a basket of utilities-sector companies.

The Bottom Line

Utility can be used to measure the usefulness of goods and services to consumers. While there
are limitations when more variables and differences appear in the market, various types of
economic utility continue to be examined. Not only can it help companies with structuring their
tiered pricing but it can also help consumers learn how to boost the utility of their purchases.

What Is Consumer Surplus?

Consumer surplus is an economic measurement of consumer benefits resulting from market

competition. A consumer surplus happens when the price that consumers pay for a product or
service is less than the price they're willing to pay. It's a measure of the additional benefit that
consumers receive because they're paying less for something than what they were willing to pay.
Consumer surplus may be compared with producer surplus.

KEY TAKEAWAYS
 A consumer surplus happens when the price consumers pay for a product or service is
less than the price they're willing to pay.
 Consumer surplus is based on the economic theory of marginal utility, which is the
additional satisfaction a consumer gains from one more unit of a good or service.
 Consumer surplus always increases as the price of a good falls and decreases as the price
of a good rises.
 It is depicted visually by economists as the triangular area under the demand curve
between the market price and what consumers would be willing to pay.
 Consumer surplus plus producer surplus equals the total economic surplus.
Understanding Consumer Surplus
The concept of consumer surplus was developed in 1844 to measure the social benefits of public
goods such as national highways, canals, and bridges. It has been an important tool in the field of
welfare economics and the formulation of tax policies by governments.
Consumer surplus is based on the economic theory of marginal utility, which is the additional
satisfaction a consumer gains from one more unit of a good or service. The utility a good or
service provides varies from individual to individual based on their personal preference.
Typically, the more of a good or service that consumers have, the less they're willing to spend for
more of it, due to the diminishing marginal utility or additional benefit they receive. A consumer
surplus occurs when the consumer is willing to pay more for a given product than the current
market price.

The Formula for Consumer Surplus

Economists define consumer surplus with the following equation:
Consumer surplus = (½) x Qd x ΔP
where:
 Qd = the quantity at equilibrium where supply and demand are equal

 ΔP = Pmax – Pd, or the price at equilibrium where supply and demand are equal
 Pmax = the price a consumer is willing to pay

Measuring Consumer Surplus

The demand curve is a graphic representation used to calculate consumer surplus. It shows the
relationship between the price of a product and the quantity of the product demanded at that
price, with the price drawn on the y-axis of the graph and the quantity demanded drawn on the x-
axis. Because of the law of diminishing marginal utility, the demand curve is downward sloping.
Consumer surplus is measured as the area below the downward-sloping demand curve, or the
amount a consumer is willing to spend for given quantities of a good, and above the actual
market price of the good, depicted with a horizontal line drawn between the y-axis and demand
curve. Consumer surplus can be calculated on either an individual or aggregate basis, depending
on if the demand curve is individual or aggregated.
Consumer surplus always increases as the price of a good falls and decreases as the price of a
good rises. For example, suppose consumers are willing to pay $50 for the first unit of product A
and $20 for the 50th unit. If 50 of the units are sold at $20 each, then 49 of the units were sold at
a consumer surplus, assuming the demand curve is constant.
Consumer surplus is zero when the demand for a good is perfectly elastic. But demand is
perfectly inelastic when consumer surplus is infinite.

Example of Consumer Surplus

Consumer surplus is the benefit or good feeling of getting a good deal. For example, let's say that
you bought an airline ticket for a flight to Disney World during school vacation week for $100,
but you were expecting and willing to pay $300 for one ticket. The $200 represents your
consumer surplus.
However, businesses know how to turn consumer surplus into producer surplus or for their gain.
In our example, let's say the airline realizes your surplus and as the calendar draws near to school
vacation week raises its ticket prices to $300 each.
The airline knows there will be a spike in demand for travel to Disney World during school
vacation week and that consumers will be willing to pay higher prices. So by raising the ticket
prices, the airlines are taking consumer surplus and turning it into producer surplus or additional
profits.

Is a High Consumer Surplus Good?

A high consumer surplus means that goods are priced quite a bit lower in the market than where
consumers would ultimately be willing to pay. This is often the result of a high degree of
competition, technological progress, and producer efficiency. In general, all of these things are
considered to be "good" for promoting economic growth and prosperity.

What Is Producer Surplus?

Similar to consumer surplus, producer surplus is the economic benefit to producers of goods
measured by the difference in market price and where the producer would be willing to sell. A
producer surplus thus exists if the market price of a good is higher than the price the producer is
willing to sell.
What Is Total Economic Surplus?
Total economic surplus is equal to the producer surplus plus the consumer surplus. It describes
the total net benefit to society from free markets in goods or services.

The Bottom Line

In free markets, producers compete with one another to be the low-cost producer and grab
market share from other companies in their space. The result is more quantity and lower prices
for consumers, often lower than where they would be willing to pay for it. This difference
between the market price (as determined by supply and demand) and the willingness to pay is the
consumer surplus. A consumer surplus is seen as a benefit to the economy.