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UTILITY ANALYSIS
Two questions arise with regard to the behaviour of the consumer: (i) why does a
consumer demand a good or a service? How does a consumer spend his income on
various goods and services so that he gets maximum satisfaction or that he may be in
equilibrium? The answer to the first question is that a consumer demands a good or
service because it gives him satisfaction/utility. The answer to the second question is
that
Economists have put forward three main theories in this regards: (i) cardinal utility
analysis, (ii) ordinal utility analysis, and (iii) revealed preference analysis.
The present chapter deals with the cardinal utility analysis.
2. CARDINAL UTILITY ANALYSIS
2.1 Utility
Utility is the capacity of a good that satisfies human want.
2.2 Features of utility
The following main features of utility merit attention:
(i) Utility is subjective: Utility is subjective because it deals with the metal
satisfaction of a man. A thing may have different utrility for different persons.
Liquor has utility for drunkardbut for a person who is teetotaller, liquor has no
utility.
(ii) Utility is relative: Utility of a commodity never remains the same. It varies
across place and time. Desert cooler has utility during summer but not during
the winter season.
(iii) Utility is not essentially useful: A commodity having utility need not be useful.
Wine and cigarrette are not useful, but it satisfies the want of a driner and
smoker and have utility for them.
(iv) Utility is independent of morality: Utility has nothing to do with morality. Use of
wine may be immoral but these satisfy the want of a drunkard and thus has
utility.
2.3 Basic assumptions of utility analysis
Utility analysis is based on the following assumptions:
(i) Rational consumer: Consumer is assumed to be rational. A rational consumer
is one who is keen to get maximum satisfaction out of his limited income.
(ii) Cardinal utility: Utility of evey commodity can be measured in terms of
cardinal numbers, such as, 1, 2, 3, 4 etc. It is measured in terms of money.
The utility is measured by money that the consumer is prepared to pay for a
unit of the commidity.
(iii) Independent utility: It is assumed that the utility that a consumer gets from a
commodity depends upon the quantity of that every commodity. It is not
affected by the utility derived from other goods.
(iv) Marginal utility of money is constant: It is assumed that money measures the
marginal utility of a commodity; as such, its own marginal utility should remain
constant so as to serve as an ideal measure.
(v) Divisibility: Goods are divisible. The quantity consumed of the commodity can
be exactly adjusted.
(vi) Diminishing marginal utility: As a consumer consumes increasing units of a
commidity, the marginal utility of the successive units of that commodity
diminishes.
(vii) Total utility depends on quantities of individual commodities: The total utility of
a basket of goods depends on the quantities of individual commodities. If
there are ‘n’ commodities in the bundle with n1, n2, …, nn quantities of total
utility is,
U = f(n1, n2, …, nn)
(iii)
2.7 Significance of the difference between total utility and marginal utility
(i) The diamond-water paradox
(ii) Consumer’s surplus
2.8 Basic laws of utility analysis
Utility analysis has two main laws:
(i) The law of diminishing marginal utility
(ii) The law of equi-marginal utility
2.9