Introduction: This Chapter consists of Utility, Law of Diminishing Marginal Utility, Budget line, budget constraint, monotonic preferences, indifference curve, and consumer equilibrium in cardinal and ordinal approaches.
Utility: Utility means human satisfaction. In other words the amount of satisfaction of a person gets from consumption of a good or service.
Utility is categorized in to two types
- Cardinal Utility approach: It is defined as a quantitative method to measure consumption satisfaction that means consuming goods and service can be measured in number.
- Ordinal Utility approach: Ordinal Utility is not like cardinal utility. It’s measured in ranks. If customer has higher satisfaction, it will be assigned as higher ranks and lower level of satisfaction will be lower ranks.
Total utility: Total utility is the total satisfaction derived from the consumption of a given units of a good.
Average utility: It is utility per unit of the good and calculated by dividing the total utility to the number of units consumed.
Marginal utility: It is the addition to the total utility derived from the consumption of an additional unit of the good.
Law of Diminishing Marginal Utility: It states that as more units of goods are consumed continuously in standard units, the marginal utility derived from the consumption of every additional unit will keep diminishing.
|Units consumed||Total Utility (in utils)||Marginal Utility(in utils)|
The above graph is Relation between total utility and Marginal utility
Consumer’s Equilibrium: If the situation of consumer gets maximum satisfaction out of his income and market price is referred as a consumer’s equilibrium.
Consumer’s equilibrium through utility analysis can be ascertained with reference to
- Single Commodity
- Two or several commodities
Single Commodity: When purchasing unit of a commodity the consumer compares its price with utility from it. Here utility is the benefit and price is the cost. So he will buy the unit of commodity only if the benefit is equal or more than cost.
The equilibrium condition of single commodity is
Marginal Utility of money= Price
Two or several Commodities: According to this, a consumer gets maximum satisfaction , when ratios of marginal utility of two commodities and their respective prices are equal.
Condition of two commodities is
Marginal Utility of last rupee spent on each commodity is same.