Module 1 Overview

Concept of Utility
Utility is a term used to describe the degree of enjoyment a customer feels after using
something. A good's ability to meet human needs is known as its utility.
Accordingly, “Utility is the satisfaction of wants through the use of goods or
services.” In the words of Frazer; “Utility is simply desiredness”. Utility in
economics, first introduced by Swiss mathematician Daniel Bernoulli in the 18th
century, has evolved into various types of economic utility. Economic theories based
on rational choice assume that consumers maximize their utility, which directly
influences the demand and price of a good or service. However, utility is often
impossible to measure or quantify. Some economists believe they can indirectly
estimate the utility of an economic good or service using various models. Utility is
a measure of an individual's consumption of different commodities, expressed as U
= f (m1, n1, r1).

Characteristics
Utility is the invisible quality of anything that fulfills human wants, arising from
human needs or wants. It is not visible or touchable but exists in abstract or invisible
forms. The ‘utility’ is not concerned with morality, but if a thing fulfils the wants
of anyone, it possesses utility. Utility is individual and relative, and is subjective,
not objective or concrete, making it applicable in all cases. Utility is thus considered
relative and quantified in monetary terms. Utility and usefulness are two different
things. The degree of desire a commodity is beneficial for may not determine its
value.

1. Total Utility
Total utility, also known as full satiety, is the satisfaction a consumer gains from
consuming various units of a good or service. It is the sum of all marginal utilities
of the individual units consumed. Total utility generally increases with each
additional unit consumed. It can be expressed as TUn = Ux + Uy + Uz or TU = ̩MU,
where TU represents Total Utility, n represents the number of commodities, Ux, Uy,
and Uz represent the respective utilities of consumption, and MU represents
Marginal Utility. Total utility is the sum of the utility a consumer derives from
different units of a commodity or service consumed at a given time.

2. Marginal Utility
Marginal utility is the utility derived from an additional unit of a commodity
consumed by an individual or the addition to the total utility of a commodity
resulting from the consumption of an additional unit. According to Samuelson, “The
term marginal utility refers to extra utility added by one extra last unit of goods.” It
is calculated as the change in total utility (∆ TU) attained from the consumption of
an additional unit of a commodity. In cases where the total number of units
consumed is n, marginal utility can be expressed as MU of the nth unit.

Marginal Utility and Total Utility Relationships

• Positive Marginal Utility increases Total Utility.
• Zero Marginal Utility maximizes Total Utility.
• Negative Marginal Utility diminishes Total Utility.
• Total Utility includes MUs, Marginal Utility represents change in Total Utility.

The relationship between marginal utility and total utility can be explained using
schedule and diagram.
The schedule shows that total utility increases from 10 to 30 when Marginal Utility
is positive until the 5th unit. At the 6th unit, marginal utility is zero, resulting in a
maximum of 30. When Marginal Utility is negative, total utility diminishes from 30
to 28. Total Utility is the sum of marginal utilities consumed by all seven units, with
the rate of change being the marginal utility. The decreasing trend starts after the 6th
unit in the T.U.
The diagram shows the relationship between commodity consumption units and
utility on the X-axis. The total utility curve is drawn by joining points a, b, c, d, e, f,
and g, while the marginal utility curve is drawn by joining points a, h, i, j, k, I, and
m. The total utility increases upward as long as the marginal utility curve doesn't
touch the horizontal axis. At the 6th unit, marginal utility is zero, and total utility
reaches its maximum point at 60. At the 7th unit, marginal utility is negative, and
total utility diminishes from f to g.

The key differences between the two are: Total utility refers to the overall benefit a
person gains from consuming goods and services, while marginal utility refers to the
utility gained from each unit of a commodity. Total utility generally increases with
more consumption, while marginal utility decreases with each additional unit. A
saturation point of satisfaction occurs when consumers no longer gain satisfaction
with the consumption of a commodity, indicating that total utility suffers from
decreasing returns.

Practical Implications in Economics:

• Consumer Equilibrium: Efficient budget allocation achieved when marginal
utility to price ratio equals across all products.
• Utility Analysis: Lower utility influences market demand and pricing strategies.

Total and Marginal Utility are fundamental economic concepts that provide crucial
insights into consumer behavior, market dynamics, resource allocation, demand
patterns, and pricing in the marketplace.

Types of Utility
Economic production can relate to the generation of utilities in several different
contexts. Understanding utility types is crucial for businesses to better serve
customers and increase revenues, as they play a significant role in user buying
decisions.

 Form Utility:
 By altering the materials' shape or form, this usefulness is produced. As an
illustration, consider a cabinet built of steel that was transformed into wood
furniture, and so forth. In essence, the production of things creates utility.

 Place Utility:
 Place utility refers to the worth of products transferred from one location to
another, such as when selling items from manufacturers to markets or moving
food grains from farmers to cities. This utility is also used in retail commerce,
distribution, fishing, and mining. It is more widespread in situations of
shortage than abundance, as seen by the higher costs of Kashmir apples in
Mumbai in comparison to Srinagar. Thus, spatial utility is an important
component of economic activities.

 Time Utility
 Time utility increases when goods are scarce, as they can be stored, hoarded,
and preserved over time. This is a fundamental aspect of trading, as it allows
traders to profit from the increased utility of scarce goods during periods of
scarcity.

 Possession Utility
 Possession utility is the value of a product that grants complete ownership and
immediate use, part of the other utilities like Form, Task, Place, and Time. It
allows customers to physically assess the product they bought, and to be
successful in competition, businesses should make possession transfer easy.
Strategies like multiple payment options and fast delivery methods can help
customers assess the product's usefulness.

 Service Utility
 This utility is created by professionals like lawyers, doctors, teachers, bankers,
and actors, who provide personal services to customers. The utility of a service
provider is specialized knowledge and skills, not commodities, requiring them
to possess the necessary skills to provide the service, such as a chartered
accountant.

 Knowledge Utility
  Businesses may increase the usability of their products or services by offering
detailed consumer information via marketing and product demos. Knowledge
utility is the understanding of a product's functions, resulting from the use of
mobile devices and increases with usage.

Measurement of Utility
Marshall presented ‘Cardinal Viewpoint’ and told utility to be measurable.
According to this viewpoint, utility can be measured in terms of money. We are
willing to pay the actual cost of an article, as nobody is willing to pay more than the
utility we derive from it. In order to have a deeper understanding of the ideas and
utility measurement, it is necessary to examine two economic perspectives on utility:
cardinal and ordinal.

 Cardinal Utility
The cardinal utility concept, introduced by neo-classical economists, is a measure of
utility expressed in fixed units like cordial numbers. Marshall used an imaginary unit
called utils to measure utility, and this approach, also known as utility analysis, is
used to analyze economic situations.

 Ordinal Utility
Ordinal utility is a psychological concept that suggests utility is subjective and varies
from person to person. J.R. Hicks and Allen introduced the ordinal approach, which
expresses utility in ranks like more or less utility. This concept, also known as
indifference curve analysis, is often considered a psychological concept that cannot
be measured. For instance, a person's love for pizza or burgers can be ranked based
on their preference for these items.

Understanding utility and its measurement approaches is crucial for comprehending

individual consumer demand behaviour and the market as a whole. Consumers
compare the utility of goods with the price they pay for them and purchase the same
commodity again as long as the utility is equal to the price to be paid for it.
Law of Diminishing Marginal Utility
The law of diminishing marginal utility is the foundation of utility analysis, stating
that the value of a good decreases as more is consumed. If satisfaction is gained from
a decline, buyers are willing to pay a lower price. This law is based on
the assumption that all commodity units are homogeneous. Utility is a psychological
concept that varies from person to person, and consumers strive for maximum
satisfaction.

Marginal utility refers to the additional satisfaction or happiness a person gains from
consuming one more unit of a good or service. Economists assume that individuals
are rational and aim to maximize their overall satisfaction from their consumption
choices. When faced with limited resources, individuals allocate their resources to
ensure the marginal utility per dollar spent is roughly equal for all goods and
services. As the consumption of one good increases, the utility of consuming that
good may decrease. The concept of diminishing marginal utility is central to
consumer equilibrium, as consumers will allocate their spending so that the marginal
utility of the last unit of each good consumed equals the price or opportunity cost of
that good. This law explains why people diversify their consumption across a variety
of goods and services and why prices are necessary in a market economy to allocate
resources efficiently.

Significance:
The diminishing marginal utility of a good is crucial for the theory of demand, as it
demonstrates that the quantity demanded of a good increases as its price falls, and
vice versa. It was first emphasized by Austrian economist, H.H. Gossen and is
named after him Gossen’s First Law.

This law applies to all objects of desire, including money, as it represents purchasing
power over all other goods. The marginal utility of money is generally never zero or
negative, as it represents a man's purchasing power over all other goods
The concept of marginal utility has numerous applications in economic theory and
policy, particularly in explaining the determination of commodity prices. It has been
used to explain the paradox of value, which was initially a challenge for Adam Smith
in “The Wealth of Nations.” Modern economists argue that the total utility of a
commodity does not determine its price, but the marginal utility is the most
important determinant. For example, water has a low relative marginal utility,
resulting in a low or zero price, while diamonds have a high relative marginal utility,
leading to higher prices.