ECO 100: Micro Economics

Atikur Rahman,
MBA (HRM), BBA (Mgts), RU
Senior Lecturer of Business Administration
Faculty of Business Studies, PCIU
Email: atikur.rahman@portcity.edu.bd

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 Utility

Suppose you went to a restaurant and ordered your favorite food.

What will you experience? Either the food satisfies your taste buds
or not. Another day you went to another restaurant an ordered the
same food. Is the experience the same? Maybe or may not be.

Similarly, if you eat your favorite ice-cream you will be happy.

What will happen in the second round? Happy, Right? Will you be
satisfied one after the other rounds? No!

• Utility is synonymous with “Pleasure”, “Satisfaction” & a

Sense of Fulfillment of Desire.
• Utility → “WANT SATISFYING POWER” of a Commodity.
• Utility is a Psychological Phenomenon.
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 Utility

Utility is a measure of satisfaction an individual gets from the

consumption of the commodities.

In other words, it is a measurement of usefulness that a consumer

obtains from any good. A utility is a measure of how much one
enjoys a movie, favorite food, or other goods.

It varies with the amount of desire.

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 Features of Utility

• It is dependent upon human wants.

• It depends on knowledge.
• Utility depends upon use.
• It is subjective.
• It depends on ownership.

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 Types of Utility

Initial Utility: The Utility Derived from the Consumption of 1st

Unit of Commodity.

Total utility: The sum of the total satisfaction from the

consumption of specific goods or services. It increases as more
goods are consumed. Total Utility (T.U.) = U1 + U2 + … + Un

Marginal utility: It is the additional satisfaction gained from each

extra unit of consumption. It decreases with each additional
increase in the consumption of a goods. MU = TUn-TUn-1

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 Laws of Diminishing Marginal Utility

Laws of Diminishing Marginal Utility states that When the

additional benefit that a person derives from a given increase of
his stock of anything diminishes with the increase in the stock that
he already has.
– Dr. Marshall

John, for example, is starving and hasn't consumed anything for a

while. When he eventually starts to consume, the very first piece
will provide him with a considerable measure of satisfaction. As he
continues to eat even more meals, his hunger will wane to the
extent that he no longer wants to eat.

The law states that the more we have of a commodity, the less we
want to have more of it as the utility derived from every success
unit of the commodity keeps on declining when more is consumed.
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Assumptions of Laws of Diminishing Marginal
Utility
• Units of commodities consumed should be identical or
homogeneous, that is, the same in all respects.

• Units should be consumed in quick succession with minimal

breaks in between.

• Units should be of a standard size, that is, neither too big nor
too small.

• The taste of the consumers should be constant.

• The utility is measurable.

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Assumptions of Laws of Diminishing Marginal
Utility
• There should be no change in the price of substitute goods. If
the prices of substitute goods change, it may become difficult to
have an idea about the utility that the consumer might get from
the main commodity.

• The consumer is rational while making consumption decisions.

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Assumptions of Laws of Diminishing Marginal
Utility
• There should be no change in the price of substitute goods. If
the prices of substitute goods change, it may become difficult to
have an idea about the utility that the consumer might get from
the main commodity.

• The consumer is rational while making consumption decisions.

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 Laws of Diminishing Marginal Utility

Cups of Total Margin

Tea Utility al
Utility
Consumed (units) (units)
per day
1 12 12
2 22 10
3 30 8
4 36 6
5 40 4
6 41 1
7 39 –2
8 34 –5
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 Laws of Diminishing Marginal Utility

In above Table & graph we see that the total and marginal utilities
derived by a person from cups of tea consumed per day. When
one cup of tea is taken per day, the total utility derived by the
person is 12 units. And because this is the first cup its marginal
utility is also 12.

With the consumption of 2nd cup per day, the total utility rises to
22 but marginal utility falls to 10. It will be seen from the table
that as the consumption of tea increases to six cups per day,
marginal utility from the additional cups goes on diminishing (i.e.,
the total utility goes on increasing at a diminishing rate).

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 Laws of Diminishing Marginal Utility

However, when the cups of tea consumed per day increase to

seven, then instead of giving positive marginal utility, the seventh
cup gives negative marginal utility equal to -2. This is because too
many cups of tea consumed per day (say more than six for a
particular individual) may cause him acidity and gas trouble.

Thus, the extra cups of tea beyond six to the individual in question
give him disutility rather than positive satisfaction.

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 Limitations of Laws of Diminishing Marginal
Utility
Very Small Units: If the units of commodities are very small then
the law does not operate.

Dissimilar units: The unit should be similar in size, quality etc.

The law of diminishing marginal utility will not operate if the units
that are consumed are not similar in size and quality.

Too long an interval: The law will also not operate if the units
are consumed after long breaks.

Mentally unstable people: People like drunkards or drug

addicts will get greater satisfaction with every successive dose of
liquor. Hence, the law fails to operate in these cases.
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 Limitations of Laws of Diminishing Marginal
Utility
Rare collections: This refers to hobbies. When people collect
rare coins and stamps for example, in such cases the person’s
satisfaction increases with every addition to his stock or collection.
The law hence cannot operate.

Not applicable to money: Money is a commodity which is

appreciated greatly by rich and poor. There is a saying that the
more money a person has the want he wants of it, hence, the law
cannot operate in the case of money.

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 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.

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’s Surplus = What a Consumer is Willing to Pay –
What he Actually Pays.
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 Consumer Surplus

Consumer surplus obtained by a person from a commodity is the

difference between the satisfaction which he derives from it and
which he forgoes in order to procure that commodity. - Prof. J. K.
Mehta

The excess of price which one is willing to pay rather than go

without the thing over that which he actually does pays, is the
economic measure of this surplus satisfaction. It may be called the
consumer’s surplus.
- Prof. Marshall

Consumer surplus is the difference between the sum which

measures the total utility and that which measures total exchange
value. - Prof. Taussig
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 Assumptions of Consumer Surplus

Utility Is Measurable: Prof. Marshall has regarded money as the

basis to measure utility because the price of any commodity is
paid due to the power in the commodity to provide utility.

Application of Law of Diminishing Marginal Utility: Prof.

Marshall has regarded the law of diminishing marginal utility as
the basis of consumer surplus.

Independent Utility of Commodity: This concept is based on

the assumption that each commodity is independent of the other,
meaning thereby that the consumption of a commodity is not
affected by the consumption of another commodity.

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 Assumptions of Consumer Surplus

Marginal Utility of Money Remains Constant: The concept of

consumer surplus assumes that the marginal utility of the money
is constant, irrespective of the quantity of money possessed by
him.

Lack of Substitute Goods: No commodity is having a substitute

commodity. If it is at all the substitute commodity, it should also
be assumed as the main commodity.

Other Things Remaining the Same: Changes in incomes,

tastes, nature and fashion of the consumers offset the effects of
each other, for measuring the consumer’s surplus. Hence, it is
assumed that these differences and variations have no effect on
consumer surplus.
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 Consumer Surplus

Units of Utility to be Market Price Consumer’s

orange derived from (In paisa) surplus
the orange (in paisa)
(In paisa)
1 250 50 250-50= 200
2 200 50 200-50= 150
3 150 50 150-50= 100
4 120 50 120-50= 70
5 100 50 100-50= 50
6 70 50 70-50= 20
7 50 50 50-50= 00
Total 940 350 940-350=
590
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 Consumer Surplus

It is evident from the table that when the consumer is willing to

purchase the first unit of orange, then he is ready to pay up to Rs.
2.50, but he has to pay only 50 paise for that. Hence, he has a
saving equal to 200 paise. Similarly, he also gets different savings
from second to sixth units. For the seventh unit, the utility derived
is the same as is the market price. Hence, for this unit, the
consumer surplus is zero.

Now, we may say that the consumer gets utility equal to 940 paise
from seven units of orange and he is ready to pay this much of
price for these. But, the market value of these seven units of
orange is equal to 350 paise. Hence, he has the saving equal to
the difference between the two, i.e. of 590 paise.
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Consumer Surplus

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 Consumer Surplus

In the diagram, Units of orange have been shown on the OX axis

and the utility obtained from the commodity and price paid have
been shown on the OY axis. OP is the market price of orange.

In the above diagram, the total utility obtained from various units
of a commodity has been shown by O.M.R.Q. For obtaining this
commodity, the price actually paid by the consumer is equal to
O.P.R.Q.

Consumer surplus, the difference between these two is equal to

P.M.R. The rectangles drawn above OP show the consumer
surplus.

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 Limitations of Consumer Surplus

Although the concept of consumer surplus has acquired a

significant place in welfare economics, the economists,
have criticized it, on the following grounds:

• This Law is Imaginary and Impractical

• Unrealistic Assumption
• Consumer Surplus does not Remain Constant
• Consumer Surplus from Necessities and Prestigious Goods
Unrealistic
• Correct Measurement of Consumer Surplus is Difficult
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 Indifference Curve

An indifference curve is a graph showing combination of two

goods that give the consumer equal satisfaction and utility. Each
point on an indifference curve indicates that a consumer is
indifferent between the two and all points give him the same
utility.

A Single Indifference Curve shows the different Combinations of X

and Y that yield Equal Satisfaction to the Consumer. - Leftwitch

An Indifference Curve is a Combination of Goods, each of which

yield the Same Level of Total Utility to which the Consumer is
Indifferent.
- Ferguson
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 Properties of Indifference Curve

• An Indifference Curve has a Negative Slope i.e. it Slopes

Downwards.

• Indifference Curves are always Convex to the Origin.

• Two Indifference Curves never Intersect or become Tangent to

Each other.

• Higher Indifference Curve represents Higher Satisfaction

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Indifference Curve

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Indifference Map

An indifference map
represents a group of
indifference curves each of
which expresses a given
level of satisfaction.

If an indifference curve shifts

to right, the level of
satisfaction goes on
increasing.

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 Budget Line

The budget line shows all those combinations of two goods which
the consumer can buy spending his given money income on two
goods at their given prices.

The budget line is a graphical delineation of all possible

combinations of the two commodities that can be bought with
provided income and cost so that the price of each of these
combinations is equivalent to the monetary earnings of the
customer.

Remember, that the amount of a good that a person can buy will
depend upon their income and the price of the good.

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Budget Line

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 Consumer Equilibrium

Consumer equilibrium is a situation in which a consumer derives

maximum satisfaction with no intention to change it and is subject
to given prices and their given income. In simple terms being in a
state of consumer equilibrium means being in a state of maximum
satisfaction. Any rational consumer would not deviate from this
state of equilibrium. This helps a consumer to maximize the utility
from consumption of fewer commodities.

The indifference map in combination with the budget line allows

us to determine the one combination of goods and services that
the consumer most wants and is able to purchase. This is the
consumer equilibrium.

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Consumer Equilibrium

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