Topic

The Law of Diminishing Marginal Utility

Chapter 5
Demand and Consumer Behavior
ECONOMICS by Sameulson Nordhaus. 19th Edition. By McGraw Hills Publications
What Is Utility?
• The simple meaning of ‘utility’ is ‘usefulness’. In economics utility is the
capacity of a commodity to satisfy human wants.
• Utility is the quality in goods to satisfy human wants. Thus, it is said that
“Wants satisfying capacity of goods or services is called Utility.”
• Utility is a term in economics that refers to the total satisfaction received
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 impossible to measure and quantify.
However, some economists believe that they can indirectly estimate what is
the utility for an economic good or service by employing various models.
 Can Utility be Measured?
• Utility is a psychological concept. This is different for different people.
Therefore, it cannot be measured directly.
• Professor Marshall has said that “Utility can be measured and its
measuring rod is ‘money. The price which we are ready to pay for an
article is practically its price. Nobody will be prepared to pay more
than the utility which we derive from the article.
• For example:
• If I am ready to pay Rs. 1500 for a watch and Rs. 2,000 for a Radio.
Then I can say that I derive utility from that watch up to the value of
Rs. 1500; and from Radio up to the value of Rs. 2,000.
• “The inference which we can draw from the above example is that
the price which we pay for any article is the utility which we derive
from that article.”
Some economist argued that measuring of utility
is not possible because of the following reasons:

• (i) Utility is personal, psychological and abstract view which cannot be

measured like goods.
• (ii) Utility is different for different people. Utility is always changeable
and it changes according to time and place. Therefore, it is difficult to
measure such thing who is of changeable nature.
• (iii) Further, measuring material ‘money is not static. Value of money
always changes, therefore, correct measurement is not possible.
Measures of Utility
• Ordinal Utility
• Cardinal Utility
Ordinal Utility
• In ordinal utility, the consumer only ranks choices in terms of
preference but we do not give exact numerical figures for utility.
• Ordinal utility analysis does not quantify utility in numerical
expressions.
• For example, we prefer a BMW car to a Nissan car, but we don’t say
by how much.
• It is argued this is more relevant in the real world. When deciding
where to go for lunch, we may just decide I prefer an Italian
restaurant to Chinese. We don’t calculate the exact levels of utility.
Cardinal Utility
• This analysis is a measurement of utility that tells how utility can be
expressed in numbers, and a consumer can express his/her satisfaction
numerically.
• The 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.
• 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.
Continue..
• Cardinal Utility is the idea that economic welfare can be directly
observable and be given a value.
• For example, people may be able to express the utility that
consumption gives for certain goods. For example, if a Nissan car gives
5,000 units of utility, a BMW car would give 8,000 units. This is
important for welfare economics which tries to put values on
consumption.
• One way to try and put values on goods utility is to see what price
they are willing to pay for a good.
• If we are willing to pay £5,000 for a second-hand Nissan Car, we can
infer we must get 5,000 utils. In other words, the value of cardinal
utility is related to the price we are willing to pay.
• The idea of cardinal utility is important to rational choice theory. The
idea consumers make optimal choices to maximise their utility.
Kinds of Utility:

• (i) Marginal Utility,

• (ii) Total Utility,

• (iii) Average Utility

 Total Utility
• Total Utility is the utility from all units of consumption. Total Utility is
the sum of the marginal utilities associated with the consumption of
the successive units.”
• 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 10 utils, the second
slice of pizza consumed yields 8 utils, and the third slice yields 2 utils,
the total utility of pizza would be 20 utils.
Mathematical representation of Total
Utility
• TU = MU = MU1 + MU2 + MU3 ………. + MUn
• Where
• TU = Total Utility
• MU = Marginal Utility
• MU = Sum of the all Marginal Utilities
• If for example, if a consumer consumes 3 biscuits and obtains 7, 5,
and 3 utils of utility from the 1st, 2nd and 3rd biscuits respectively then
the Total Utility is 7+5+3 = 15 Utils.
 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.
• Marginal utility (MU) is defined as the additional utility gained from
the consumption of one additional unit of a good or service.
 Mathematical representation of
Marginal Utility
• MU = TU / Q
• Where
• TU = Change in total utility
• Q = Change in the unit of commodity consumed by consumer
The relationship between Marginal Utility and Total Utility
The relationship between Marginal Utility and Total Utility
• In diagram A OY line shows Total Utility and is diagram B OY line
shows Marginal Utility. As the number of bread increases Marginal
Utility goes on diminishing and Total Utility goes on increasing.
• (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
and Total Utility is on maximum point.
• (5) When Marginal Utility becomes negative, Total Utility decreases.
• (6) Increase in Total Utility depends on Marginal Utility.
• (7) Since Marginal Utility diminishes, Total Utility increases at a
 Average Utility:
• Average Utility is that utility in which the total unit of consumption of
goods is divided by number of Total Units.
• For example—If the Total Utility of 4 bread is 40, then the average
utility of 3 bread will be 12.
• If the Total Utility of 3 bread is 36 i.e., (36 ÷ 3 = 12).
 Introduction to Law of Diminishing
Marginal Utility
• Law of Diminishing Marginal Utility was first of all introduced by a
German Scientist H. H. Gossen in the year 1854.
• The law of diminishing marginal utility states that all else equal, as
consumption increases, the marginal utility derived from each
additional unit declines.
 Assumption of the Law of
diminishing marginal utility
• 1. The process of consumption should be continuous
• 2. Units of the commodity should be of normal standard units:
• 3. There should be no change in the taste, fashion and habit of the
consumer:
• 4. Behaviour of the consumer should be normal and rational:
Table for the Law of Diminishing Marginal
Utility