Week 2

UTILITY

Meaning of 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.”

In this way utility is measured in terms of money and it is relative.

There is difference between utility and usefulness. A useful
commodity may not here utility of goods depend upon the intensity
of wants.

A consumer buys or demands a particular commodity he derives

some benefit from its use. He feels that his given want is satisfied by
the use or consumption of the commodity purchased. Utility is the
basis of consumer demand. A consumer thinks about his demand for
a commodity on the basis of utility derived from the commodity.

Utility depends upon the intensity of want. When a want is

unsatisfied or more intense, there is a greater urge to demand a
particular commodity which satisfies a given want. In modern time
utility has been called as ‘expected satisfaction.’ Expected satisfaction
may be less or equal to or more than the real satisfaction.

Definition of Utility:

Various economists have defined utility as follows:

1. According to Prof. Waugh :

“Utility is the power of commodity to satisfy human wants.”

2. According to Fraser :

“On the whole in recent years the wider definition is preferred and
utility is identified, with desireness rather than with satisfyingness.”
Characteristics of Utility:

The following are the important characteristic features of utility:

1. Utility has no Ethical or Moral Significance:

A commodity which satisfies any type of want, whether moral or

immoral, socially desirable or undesirable, has utility, i.e., a knife has
utility as a household appliance to a housewife, but it has also a
utility to a killer for stabbing some body.

2. Utility is Psychological:
Utility of a commodity depends on a consumer’s mental attitude and
assessment regarding its power to satisfy his particular want. Thus,
utility of a commodity may differ from person to person.
Psychologically, every consumer has his likes and dislikes and
everyone determines his own level of satisfaction.

For instance:

A consumer who is fond of apples may find a high utility in apples in

comparison to the consumer who has no liking for apples. Similarly a
strictly vegetarian person has no utility for mutton or chicken.

3. Utility is always individual and Relative:

Utility of a commodity varies in different situations in relation to time

and place. Even the same consumer may derive a higher or lower
utility for the same commodity at different times and different
places. For example—a person may find more utility in woolen
clothes during the winter than in summer or at Kashmir than at
Mumbai.

4. Utility is not necessarily equated with Usefulness:

Utility simply means the ability to satisfy a want. A commodity may

have utility but it may not be useful to the consumer. For instance—A
cigarette has utility to the smoker but it is injurious to his health.
However, demand for a commodity depends on its utility rather than
its usefulness. Thus many commodities like opium liquor, cigarettes
etc. have demand because of utility, even though, they are harmful to
human beings.

5. Utility cannot be measured objectively:

Utility being a subjective phenomenon or feeling of a consumer

cannot be expressed in numerical terms. So utility cannot be
measured cardinally or numerically. It cannot be measured directly in
a precise manner. Professor Marshall has however, unrealistically
assumed cardinal measurement of utility in his analysis of demand.

6. Utility Depends on the Intensity of Want:

Utility is the function of intensity of want. A want which is unsatisfied

and greatly intense will imply a high utility for the commodity
concerned to a person. But when a wan is satisfied in the process of
consumption it tends to experience a lesser utility of the commodity
than before. Such an experience is very common and it is described
as a tendency of diminishing utility experienced with an increase in
consumption of a commodity. In other words, the more of a thing we
have, the less we want it.

7. Utility is Different from Pleasure:

A commodity may have utility but its consumption may not give any
pleasure to the consumer, e.g., medicine or an injection. An injection
or medicinal tablet gives no pleasure, but it is necessary for the
patient.

8. Utility is also Distinct from Satisfaction:

Utility and satisfaction, both are though inter-related but they have
not been considered as the same in a strict sense.

Different Types of Utility:

In economics, production refers to the creation of utilities in several

ways.

Thus, there are following types of utility:

1. Form Utility:
This utility is created by changing the form or shape of the materials.
For example—A cabinet turned out from steel furniture made of
wood and so on. Basically, form utility is created by the
manufacturing of goods.

2. Place Utility:

This utility is created by transporting goods from one place to

another. Thus, in marketing goods from the factory to the market
place, place utility is created. Similarly, when food-grains are shifted
from farms to the city market by the grain merchants, place utility is
created.

Transport services are basically involved in the creation of place

utility. In retail trade or distribution services too, place utility is
created. Similarly, fisheries and mining also imply the creation of
place utility. Place utility of a commodity is always more in an area of
scarcity than in an area of scarcity than in an area of abundance e.g.,
Kashmir apples are more popular and fetch higher prices in Pune than
in Srinagar on account of such place utility

3. Time Utility:

Storing, hoarding and preserving certain goods over a period of time

may lead to the creation of time utility for such goods e.g., by
hoarding or storing food-grains at the time of a bumper harvest and
releasing their stocks for sale at the time of scarcity, traders derive
the advantage of time utility and thereby fetch higher prices for food-
grains. Utility of a commodity is always more at the time of scarcity.
Trading essentially involves the creation of time utility.

4. Service Utility:

This utility is created in rendering personal services to the customers

by various professionals, such as lawyers, doctors, teachers, bankers,
actors etc.

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.”
But Prof. Hicks, Allen and Pareto have not supported Marshall’s view
of measuring utility.

They are of this opinion 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 3.that is of changeable nature.

(iii) Further, measuring material ‘money is not static. Value of money

always changes, therefore, correct measurement is not possible.

Kinds of Utility:

Utility are of three kinds:

(i) Marginal Utility,

(ii) Total Utility,

(iii) Average Utility

(i) Marginal Utility:

Definition:
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.

According to Prof. Boulding—”The marginal utility of any quantity of

a commodity is the increase in total utility which results from a unit
increase in its consumption.”

For example:

Suppose Mr. Shanker is consuming bread and he takes five breads. By

taking first unit he derives utility up to 20; second unit 16; third unit
12; fourth unit 8 and from fifth 2. In this example the marginal unit is
fifth bread and the marginal utility derived is 2. If we will consume
only four bread then the marginal unit will be fourth bread and utility
will be 8.

Kinds of Marginal Utility—Marginal utility is of three kinds:

(i) Positive Marginal Utility,

(ii) Zero Marginal Utility,

(iii) Negative Marginal Utility.

It is a matter of general experience that if a man is consuming

particular goods, then receiving of next unit of goods reduces the
utilities of the goods and ultimately a situation comes when the
utility given by the goods become zero and if the use of the goods still
continues, then the next unit will give disutility. In other words it can
be said that we will derive “negative utility”.

This can be studied better by the following table:

From the table given above it is clear that up to the consumption of
the fifth bread we receive positive utility; 6th unit is the unit of full
satisfaction i.e., Utility derive from that unit is zero. From 7th unit the
utility received will be negative utility. The table can be represented
in shape of diagram as follows: In diagram No. 1 OX axis (line) shows
unit of bread and OY line shows the Marginal Utility received. From
the figure it is clear that from the first unit of bread utility received
are 20 which has been shown on the top of the line.

Similarly 2, 3, 4, 5 Unit of bread’s utility is 16, 12, 8, 4 respectively All

these have been shown on OX line which shows positive marginal
utility. Utility of the sixth bread is zero and that of the seventh bread
is negative and negative rectangle has been shown below OX line.

Zero Utility:

When the consumption of a unit of a commodity makes no addition

to the total utility, then it is the point of Zero Utility. In our table the
total utility, after the 6th unit is consumed. This is the point of Zero
Utility. It is thus seen that the total utility is maximum when the
Marginal Utility is zero.

Negative Utility:

Negative Utility is that utility where if the consumption of a

commodity is carried to excess, then instead of giving any
satisfaction, it may cause dissatisfaction. The utility is such cases is
negative. In the table given above the marginal utility of the 7th unit
is negative.

(ii) Total Utility:

Total Utility is the utility from all units of consumption. According to

Mayers—”Total Utility is the sum of the marginal utilities associated
with the consumption of the successive units.”

For example:

Suppose, a man consumes five breads at a time. He derives from first

bread 20 units of satisfaction from 16, from third 12, from fourth 8
and from fifth 4 i.e., total 60 units.

This can be shown by the following table:

(iii) Average Utility:

Average Utility is that utility in which the total unit of consumption of

goods is divided by number of Total Units. The Quotient is known as
Average Utility. 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).
The following table will explain the point clearly:

It is clear from the above table that by the increasing use of any
article Marginal and Average Utility reduces gradually and Total
Utility increases only up to that point where the Marginal Utility
comes to zero.

Relation between Total Utility and Marginal Utility:

There is a close relationship between Total Utility and Marginal

Utility. As there is increase in the unit of a particular commodity, the
Marginal Utility goes on diminishing and Total Utility goes on
increasing. Total Utility goes on increasing up to that extent till the
Marginal Utility becomes Zero. When Marginal Utility is zero Total
Utility is maximum.

After Zero Marginal Utility comes to negative and the result is that
Total Utility starts reducing relationship between Total Utility and
Marginal Utility can be started as follows:

(i) When Marginal Utility is reducing, the Total Utility will increase so
long Marginal Utility does not become zero.

(ii) When Marginal Utility becomes zero; Total Utility will be

maximum.

(iii) After zero when Marginal Utility is negative then there is

reduction in Total Utility.

Relationship between Marginal Utility and Total Utility can be

studied from the following:
From the above table it is clear that up to fourth bread Marginal
Utility is positive and there is no regular increase in the Total Utility.
And on fifth bread the Marginal Utility is zero and on this point the
increase in Total Utility stops. This is point of safety. As Prof.
Bounding has said that “Point of full satisfaction and point of full
safety is that point where consumption increases but there is no
increase in Total Utility.” If after fifth bread, extra bread is consumed
then there will be dis-utility and Marginal Utility will be negative.
Sixth and seventh bread shows dis-utility.

The relationship between Marginal Utility and Total Utility will be

shown by diagram as follows:

In both the diagrams OX line shows bread. In diagram No. 1 OY line

shows Marginal Utility and is diagram No. 2 OY line shows Total
Utility. As the number of bread increases Marginal Utility goes on
diminishing and Total Utility goes on increasing—To remember:
(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.

(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

diminishing rate.

(8) When Marginal Utility is Zero, Total Utility is maximum.

(9) When Marginal Utility is negative, Total Utility declines.

The Law of Diminishing Marginal Utility (With Diagram)

One of the characteristics of human wants is their limited intensity.
As we have more of anything in succession, our intensity for its
subsequent units diminishes. This generalization of satiable wants is
known as the Law of Diminishing Marginal Utility.

Hermann Heinrich Gossen was the first to formulate this law in 1854
though the name was given by Marshall. Jevons called it Gossen’s
First Law.

Gossen stated it thus:

“The magnitude of one and the same satisfaction, when we continue

to enjoy it without interruption, continually decreases until satiation
is reached.”

Taking the example of apples as shown in column (3) of Table 1, when

our hypothetical consumer takes the first apple he derives the
maximum satisfaction in terms of 20 utility. As he continues to
consume the second, third and the fourth units in succession, he
derives less and less satisfaction 15, 10 and 5 utils respectively.

With the consumption of the 5th apple he reaches the satiety point
because the satisfaction derived from that unit is zero.

Diagrammatically, the curve MU is the diminishing utility curve in

Figure 1. It shows that marginal utility diminishes as more and more
units of the commodity (apple) are consumed till the satiety point С is
reached. Consumption of further units gives disutility, as shown by
the movement of the MU curve from point С downward below the X-
axis.

Its Limitations:

This is a universal law and holds true in the case of physiological,

social or artificial wants. It is another thing that in the case of certain
commodities the limit of satiety is soon reached, while others take
some time.

But the law holds only under certain conditions given below:

(1) Homogeneous Units:

There should be a single commodity with homogeneous units wanted

by an individual consumer. All units of the commodity should be of
the same weight and quality. If, for example, the first apple is sour
and the second sweet, the second will give greater satisfaction than
the first.
(2) No Change in Tastes:

There should be no change in the tastes, habits, customs, fashions

and income of the consumer. A change in any one of them will
increase rather than diminish utility.

(3) Continuity:

There should be continuity in the consumption of the commodity.

Units of the commodity should be consumed in succession at one
particular time. Pieces of bread taken at random may increase utility.

(4) Suitable Size Units:

Units of the commodity should be of a suitable size. Giving water to a

thirsty person by spoons will increase the utility of the subsequent
spoons of water.

(5) Constant Prices:

Prices of the different units and of the substitutes of the commodity

should remain the same.

(6) Indivisible Goods:

The commodity should not be indivisible. In the case of durable

consumer goods it is not possible to calculate their utility because
their use is spread over a period of time. Moreover, a consumer does
not buy five scooters, six television sets or even three sewing
machines for his personal consumption.

(7) Rational Consumers:

The consumer should be an economic man, who acts rationally. If he

is under the influence of an intoxicant, say wine or opium, the utility
of the latter units will rise. But this exception is not wholly true. In
the beginning the marginal utility of each peg rises but ultimately it
starts falling and even becomes negative when a drunkard starts
vomiting.

(8) Ordinary Goods:

Goods should be of an ordinary type. If they are commodities, like
diamonds and jewels, or hobby goods like stamps, coins or paintings,
the law does not apply. The utility of the additional coins or jewels
may be greater than the earlier pieces. But this view is not correct.

For the law also applies in their case. The collector of coins or jewels
will never like to have innumerable pieces of the same coin or jewels.
Similarly, the marginal utility of the second set of a particular issue of
stamps will diminish for the stamp collector if he already possesses
one.

(9) MU of Money not Constant:

Our intensity for money increases as we have more of it. No doubt

the marginal utility of money does not become zero, but it definitely
falls as a person acquires more and more money. The marginal utility
of money for a rich man is less while it is high for a poor man. If it
were not so, the rich would not spend extravagantly on luxuries and
ostentatious living.

Importance of the Law:

This law is of great importance in economics.

1. The Law of Diminishing Marginal Utility is the basic law of

consumption. The Law of Demand, the Law of Equi-marginal Utility,
and the Concept of Consumer’s Surplus are based on it.

2. The changes in design, pattern and packing of commodities very

often brought about by producers are in keeping with this law. We
know that the use of the same good makes us feel bored; its utility
diminishes in our estimation. We want variety in soaps, toothpastes,
pens, etc. Thus this law helps in bringing variety in consumption and
production.

3. The law helps to explain the phenomenon in value theory that the
price of a commodity falls when its supply increases. It is because
with the increase in the stock of a commodity, its marginal utility
diminishes.
4. The famous “diamond-water paradox” of Smith can be explained
with the help of this law. Because of their relative scarcity, diamonds
possess high marginal utility and so a high price. Since water is
relatively abundant, it possesses low marginal utility and hence low
price even though its total utility is high. That is why water has low
price as compared to a diamond though it is more useful than the
latter.

5. The principle of progression in taxation is also based on this law. As

a person’s income increases, the rate of tax rises because the
marginal utility of money to him falls with the rise in his income.

Lastly, this law underlies the socialist plea for an equitable

distribution of wealth. The marginal utility of money to the rich is
low. It is, therefore, advisable that their surplus wealth be acquired
by the state and distributed to the poor who possess high marginal
utility for money.