Utility and Cardinal Utility

analysis
Contents
I. Introduction to Utility Analysis
a) Meaning of Utility
b) Cardinal Utility analysis and Ordinal Utility Analysis
c) Total Utility and Marginal Utility
II. Cardinal Utility
a) Assumptions of Cardinal Utility analysis
b) Law of Diminishing Marginal Utility
c) Law of Equal-Marginal Utility
III. Critical evaluation of Cardinal Utility analysis
IV. Conclusion
1. Introduction to Utility Analysis

a) Meaning of Utility
b) Cardinal Utility analysis and Ordinal
Utility Analysis
c) Total Utility and Marginal Utility
I. Introduction to Utility Analysis
Meaning of Utility
Utility means - The power of a commodity that satisfy
the wants of consumer - want satisfying power

Introduced by Jermy Bentham
Measurement Utils
Subjective entity


Cardinal Utility analysis and Ordinal Utility Analysis
Cardinal Utility analysis and Ordinal Utility Analysis
Cardinal Utility analysis

Ordinal Utility Analysis
Utility Analysis
Alfred Marshal
can be measured
Utils
Law of Diminishing Marginal
Utility
Quantitative
. Subjective entity or Personal
Law of Equi-marginal Utility
Mashellian Analysis
J. R. Hicks & R.G.D. Allen
Cannot be measured but compared
as rank
Indifference Curve analysis
CARDINAL AND ORDINAL UTILITY
1. Cardinal Utility: The numbers 1, 2, 3, 4 are cardinal numbers. For
example the number 2 is twice the size of 1. In the same way, the
number 4 is four times the size of number 1.
2. Alfred Marshall developed cardinal utility analysis.
3. According to cardinal approach, utility can be measured.

1. Ordinal utility: The numbers 1st, 2nd, 3rd, and 4th, are ordinal
numbers. These ordinal numbers are ranked or ordered. This ranking
does not explain the actual size relation of the numbers. The second
one might or might not be twice as big as the first one.
2. Hicks and Allen used ordinal utility approach for analyzing the
consumer behavior. This analysis is known as indifference curve
analysis.
Total Utility(TU) and Marginal Utility(MU)
Total Utility(TU) and Marginal Utility(MU)
Unit of
Mango
Total
Utility
Marginal
Utility
1 10
2 20
3 29
4 37
5 43
6 48
7 51
8 52
9 52
10 50
Total Utility is the sum utility derived
from the consumption of bundle of
commodity


Marginal Utility is the rate of change
of TU from one more unit of extra
consumption
MUn = TUn TUn-1
MU =TU/Q
Total Utility(TU) and Marginal Utility(MU)
Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
Total Utility is the sum utility
derived from the consumption of
bundle of commodity


Marginal Utility is the rate of
change of TU from one more unit of
extra consumption
MUn = TUn TUn-1
MU =TU/Q
Chapter 21 - Consumer Choice 11
Utility Theory
Marginal Utility
The change in total utility due to a one-unit
change in the quantity of a good or service
consumed
Marginal utility =
Change in total utility
Change in number of units consumed
I. Introduction to Utility Analysis
a) Meaning of Utility
b) Cardinal Utility analysis and Ordinal Utility Analysis
c) Total Utility and Marginal Utility
II. Cardinal Utility
a) Assumptions of Cardinal Utility analysis
b) Law of Diminishing Marginal Utility
c) Law of Equal-Marginal Utility
III. Critical evaluation of Cardinal Utility analysis
IV. Conclusion
2. Cardinal Utility Analysis

a) Assumptions of Cardinal Utility analysis
b) Law of Diminishing Marginal Utility
c) Law of Equal-Marginal Utility
Assumptions of Cardinal Utility analysis
1. Rationality of consumer
2. Cardinal measurability of utility
3. Marginal Utility of Money is constant
4. Diminishing Marginal Utility
5. Utility is Additive TU= Ux+ Uy+ Uz+.+ Un
6. The hypothesis of Independent Utility
7. Introspective method

Law of Diminishing Marginal Utility
Gossen First law
Law of Diminishing Marginal Utility
Gossen first law
According to Alfred Marshall the additional
utility which a person derive from the
consumption a commodity diminishes, that is
Total Utility increase at an diminishing rate

The Law of Diminishing Marginal Utility
1. It is a psychological fact that when a person acquires more
and more units of the same commodity during a particular
time, the utility he derives from the successive units will
diminish. In other words, the additional satisfaction
derived from the additional units of a commodity goes on
decreasing.
2. H.H Gossen was the first economist to explain the law of
diminishing marginal utility, and the law of equi marginal
utility in 1854. W.S Jevons named them as Gossen first and
second laws of consumption (1871). In 1890 Marshall in his
Principle of Economics developed this analysis in a
refined manner
Definition of the Law
Alfred Marshall defines the Law of
Diminishing Marginal Utility as The
additional benefit which a person derives from
a given increase of his stock of a thing
diminishes with every increase in the stock that
he already has.
In the words of K.E Boulding As a
consumer increases the consumption of any
one commodity, keeping constant the
consumption of all other commodities the
marginal utility of the variable commodity
must eventually decline
Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a
commodity diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10
2 20
3 29
4 37
5 43
6 48
7 51
8 52
9 52
10 50
MUn = TUn TUn-1
MU =TU/Q
Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a
commodity diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
TU
MU
No of mango
No of mango
TU
MU
Law of Diminishing Marginal Utility
TU
MU
Saturation Point MU =0 or TU is maximum
TU
MU
No of mango
No of mango
The relationship between total utility and
marginal utility
1. When total utility increases at diminishes
rate, marginal utility diminishes.
2. When total utility is maximum, marginal
utility becomes zero.
3. When total utility decreases, marginal utility
becomes negative.
Application of Law of Diminishing Marginal Utility
Application of Law of Diminishing Marginal Utility
1. Bases of law of demand- why demand curve
slops downward
2. Law of equi- marginal utility is derived
3. Consumer surplus derived
4. Progressive Tax can be justified
5. Water-diamond paradox resolve
Law of Equal-Marginal Utility
Consumers Equilibrium under Marshellian analysis
(Goosens Second Law)
Law of Equal-Marginal Utility
Consumers Equilibrium under Marshellian analysis
Gossen Second Law
Explain how consumer is maximize his satisfaction by allocating his income with
different commodity at various prices.


Condition for consumer equilibrium two commodity
MUx
/
Px
=
MUy
/
Py
= .
MUn
/
P n
= MU m

MUx
/
Px
=
MUy
/
Py
= MU m

Condition for consumer equilibrium more commodity
The Law of Equi Marginal Utility:
1. The law of equi marginal utility explains as to how a consumer
distributes his limited income among various commodities
2. He will spend his income in such away that the last rupee spent on
each of the commodity gives him the same marginal utility.
3. Therefore, this law is known as the Law of Equi-Marginal Utility.
4. In order to get maximum satisfaction out of his limited income, the
consumer carefully weighs the satisfaction obtained from each
rupee that he spends. If he thinks that a rupee spent on one
commodity has greater utility than spending it on another
commodity, he will go on spend his money on the former till the
satisfaction derived from the last rupee spent in the two cases
equal
Illustration of the Law
The law of equi-marginal utility has been stated by Marshall as
follows If a person has a thing which can be put to several
uses, he will distribute it among the uses in such a way that it
has the same marginal utility in all.

The law can be explained with the help of a numerical example
suppose a consumer has Rs 5/- which he wants to spend on
two types of commodities namely X and Y so that he obtains
maximum utility. The following table shows the marginal
utilities of successive rupees of income when spends on X and Y.
Figures in the brackets shows as to how
the consumer spent his Rs 5/- on two types
of commodities. Let us assume that the
price of each commodity is one rupee. The
consumer starts spending his first rupee on
X because the highest marginal utility on X
is 10 utils. In the same way he spends his
2nd, 3rd, 4th and 5th rupee on the
commodities which gives highest utility.
Thus the total utility obtain from X and Y
will be 38, i.e. from X (10+8+6=24) and
from Y (8+6=14). In this way the consumer
spends his entire income on X and Y in such
way that the last rupee spent on X and Y
gives the same marginal utility. Thus the
consumer gets maximum satisfaction
Units Mux Muy
1 10(1) 8 (2)
2 8 (3) 6 (4)
3 6 (5) 4
4 4 2
5 2 0
Total 30 20
Law of Equal-Marginal Utility
Consumers Equilibrium under Marshellian analysis
Gossen Second Law
Explain how consumer is maximize his satisfaction by allocating his income with
different commodity at various prices.

1 2 3 4 5 6 6 5 4 3 2 1
MU (Y)
MU (X)
Unit of B Unit of A
Marginal Utility
Critical evaluation of Cardinal Utility analysis
Critical evaluation of Cardinal Utility analysis
Utility is not Cardinally measurable
Marginal Utility of money is not constant
Inadequacy of methods of introspection
Utilities are n interdependence
Failure to explain Giffen Paradox
Failure to distinguish income effect and
substitution effect