GR-10

4TH PERIOD ECONOMICS NOTES

TOPIC: THE THEORY OF CONSUMER BEHAVIOR

Concept of Utility

Utility - A measure of consumer satisfaction received from consuming a good or service. It also
measures the capacity of a commodity to satisfy human wants.

Kinds of Utility:
There are three kinds of utility, we will discuss two:
a. Marginal Utility
b. Total Utility

A. Marginal Utility - Marginal utility is the utility derived from the last or marginal unit of
consumption. It refers to the additional utility derived from an extra unit of the given commodity
purchased, acquired or consumed by the consumer.

It is the net addition to total utility made by the utility of the additional or extra units of the commodity
in its total stock. It has been said—as the last unit in the given total stock of a commodity.
According to Prof. Boulding—”The marginal utility of any quantity of a commodity is the increase in
total utility which results from a unit increase in its consumption.”

For example:
Suppose Mr. Shanker is consuming bread and he takes five breads. By taking first unit he derives
utility up to 20; second unit 16; third unit 12; fourth unit 8 and from fifth 2. In this example the
marginal unit is fifth bread and the marginal utility derived is 2. If we will consume only four bread
then the marginal unit will be fourth bread and utility will be 8.
- Kinds of Marginal Utility
a. Positive Marginal Utility
b. Zero Marginal Utility
c. Negative Marginal Utility

It is a matter of general experience that if a man is consuming particular goods, then receiving of next
unit of goods reduces the utilities of the goods and ultimately a situation comes when the utility given
by the goods become zero and if the use of the goods still continues, then the next unit will give dis-
utility. In other words it can be said that we will derive “negative utility”.

This can be studied better by the following table:

From the table given above it is clear that up to the consumption of the fifth bread we receive positive
utility; 6th unit is the unit of full satisfaction i.e., Utility derive from that unit is zero. From 7th unit the
utility received will be negative utility. The table can be represented in shape of diagram as follows: In
diagram No. 1 OX axis (line) shows unit of bread and OY line shows the Marginal Utility received.
From the figure it is clear that from the first unit of bread utility received are 20 which has been shown
on the top of the line.

Similarly 2, 3, 4, 5 Unit of bread’s utility is

16, 12, 8, 4 respectively All these have been
shown on OX line which shows positive
marginal utility. Utility of the sixth bread is
zero and that of the seventh bread is
negative and negative rectangle has been
shown below OX line.

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, after the 6th unit is consumed. This is the point of
Zero Utility. It is thus seen that the total utility is maximum when the Marginal Utility is zero.

Negative Utility:
Negative Utility is that utility where if the consumption of a commodity is carried to excess, then
instead of giving any satisfaction, it may cause dis-satisfaction. The utility is such cases is negative. In
the table given above the marginal utility of the 7th unit is negative.

B. TOTAL UTILITY:

Total Utility is the utility from all units of consumption. According to Mayers—”Total Utility is the
sum of the marginal utilities associated with the consumption of the successive units.”

For example:
Suppose, a man consumes five breads at a time. He derives from first bread 20 units of satisfaction
from 16, from third 12, from fourth 8 and from fifth 4 i.e., totals 60 units.

This can be shown by the following table:

The Law of Diminishing Utility:
An economic law that states that, all else being equal, as consumption increases, the satisfaction
derived from each additional unit decreases.

Relation between Total Utility and Marginal Utility:

There is a close relationship between Total Utility and Marginal Utility. As there is increase in the unit
of a particular commodity, the Marginal Utility goes on diminishing and Total Utility goes on
increasing. Total Utility goes on increasing up to that extent till the Marginal Utility becomes Zero.
When Marginal Utility is zero Total Utility is maximum.

Relationship between Marginal Utility and Total Utility can be studied from the following:

From the above table it is clear that up to fourth bread Marginal Utility is positive and there is no
regular increase in the Total Utility. And on fifth bread the Marginal Utility is zero and on this point
the increase in Total Utility stops. This is point of safety. As Prof. Bounding has said that “Point of
full satisfaction and point of full safety is that point where consumption increases but there is no
increase in Total Utility.” If after fifth bread, extra bread is consumed then there will be dis-utility and
Marginal Utility will be negative. Sixth and seventh bread shows dis-utility.

The relationship between Marginal Utility and Total Utility will be shown by diagram as
follows:

In both the diagrams OX line shows bread. In diagram No. 1 OY line shows Marginal Utility and is
diagram No. 2 OY line shows Total Utility. As the number of bread increases Marginal Utility goes on
diminishing and Total Utility goes on increasing—To remember:
(1) Marginal Utility goes on diminishing with the consumption of every additional unit of bread.
(2) Total Utility goes on increasing with the consumption of every additional unit but at a diminishing
rate.
(3) Marginal Utility is equal to the increase in the Total Utility. Total Utility is the sum total of the
Marginal Utilities derived from all the units consumed.
(4) When Marginal Utility becomes 0, total utility does not increase.
(5) When Marginal Utility becomes negative, Total Utility decreases.
(6) Increase in Total Utility depends on Marginal Utility.

Application of Marginal Utility Theory:

Marginal utility is widely applied in various economic theories and models, particularly in consumer
choice theory. It helps explain how consumers allocate their limited resources among different goods
and services to maximize their overall satisfaction.

Now, let us discover the real-world use of the concept of marginal utility.

1. Understanding Consumer Behavior

One of the biggest applications of marginal utility theory is that it helps retail businesses in
formulating assumptions based on consumer behavior.

By extracting insights into the psyche of consumers and discovering how much a consumer is willing
to pay for a commodity and for how many units, it is helpful for companies to place the worth of their
products and target customers accordingly.

2. Product Pricing

Another application of marginal utility is in the field of product pricing. As soon as companies
discover the worth of their products with the help of consumer behavior, they are all set to determine
the prices of their products.

By testing an aggregate price a consumer is willing to pay for a commodity, companies usually fix the
prices of their product in that particular price bracket to make their products a success in the market.

3. Progressive Taxation Policies

The third of all applications of marginal utility can be observed in the field of progressive taxation
policies while fixing the rate of taxes.

As utility determines the purchasing behavior of consumers, it is directly proportional to the taxation
system that is put in place by the government of a country.

Assuming that people with high incomes are able to spend more in comparison to the people who earn
less. Whereas a flat taxation policy can have harmful repercussions on the income of the consumers

Indifferent Curve and Marginal Rate of Substitution

Indifference Curve
It is a curve that shows the combination of goods which gives the same level of satisfaction to the
consumers so that an individual is indifferent. In other words, the consumer gives equal preference to
all such combinations.

It is a graph that gives a consumer equal satisfaction, making the consumer indifferent. An
indifference curve shows the combination of services which a consumer can prefer over the other.
Marginal Rate of Substitution

The Marginal Rate of Substitution can be defined as the rate at which a consumer is willing to forgo a
number of units good X for one more of good Y at the same utility. The Marginal Rate of
Substitution is used to analyze the indifference curve.

The concept of consumer surplus

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.