Consumer Behaviour: Utility Analysis | UGC NET Commerce Preparation Course PDF Download

What is Utility Analysis? 

Utility analysis is a key concept in consumer demand theory that helps us understand market demand in economics. It focuses on studying consumer behavior, particularly their purchasing decisions, based on the satisfaction (utility) they derive from consuming goods.

Definitions of Utility

Utility is a concept that refers to the satisfaction or benefit that a person derives from consuming a good or service. Here are some simplified definitions of utility provided by different authors:

• Prof. Alfred Marshall: Utility is the measure of how well a thing satisfies a person's wants at a particular time.
• Prof. S.E Thomas: An article possesses utility in the economic sense as long as it satisfies a person's physical or mental desires, even if it may have harmful effects on the consumer or others.
• Prof. Lipsey and Prof. Sticner: The satisfaction a person derives from consuming commodities is termed as their utility.

Characteristics of Utility

• Utility Is Not Related With Usefulness or Welfare: Utility refers to the satisfaction of human wants, regardless of whether those wants are beneficial or harmful. For instance, while excessive consumption of wine may have negative societal implications, it can still provide mental satisfaction to the consumer. Therefore, utility is not tied to usefulness or welfare.
• Utility is Measurable: The concept of utility can be quantified in terms of money. When a consumer purchases a commodity, the money spent serves as a measure of the utility derived. This allows for the comparison of the relative utility of two different goods. Utility is assessed using the cardinal approach, where it is quantified in monetary terms, enabling mathematical operations like addition, subtraction, and multiplication.
• Utility is a Relative Term: The value of utility is not absolute but is determined in relation to other goods and services. It depends on the context in which it is being considered, making it a relative concept.
• Utility is Subjective: Utility is based on individual preferences and perceptions. What one person finds valuable or satisfying may differ from another person's evaluation of the same good or service. This subjectivity is a key aspect of utility.
• Utility Depends on the Intensity of Want: The level of utility derived from a commodity is influenced by the intensity of the consumer's desire or need for that particular item. The stronger the desire, the higher the utility.
• Utility is Concerned with Consumer Goods Only: Utility is primarily associated with goods and services that satisfy human wants. It focuses on the satisfaction derived from consuming or using these commodities.
• No Physical Shape: Utility is an abstract concept and does not possess a physical form. It exists in the realm of satisfaction and fulfillment, rather than material or tangible attributes.
• Utility Does Not Depend on Actual Consumption: The utility of a product is not solely determined by its consumption. Even the anticipation of using a good or service can contribute to the overall utility derived from it. This highlights the psychological aspect of utility.
• Rationality of the Consumer: The concept of utility assumes that consumers make rational choices to maximize their satisfaction. It is based on the idea that individuals weigh the costs and benefits of different options before making a decision.

Features of Utility

Utility has several key characteristics:

• Utility is Subjective: Utility is subjective because it is based on individual preferences and satisfaction. Different people derive different levels of utility from the same commodity. For example, a smoker finds utility in cigarettes while a non-smoker does not.
• Utility is Relative: The usefulness of a good can change depending on factors like time and place. For instance, a fan is useful in the summer but not as much in the winter. This shows that utility is not a fixed attribute but varies with circumstances.
• Utility and Usefulness: While utility is related to satisfaction, it doesn't always imply usefulness. Some goods, like cigarettes and alcohol, can be harmful to health, yet they hold utility for individuals who derive satisfaction from them despite the potential harms.
• Utility and Morality: The concept of utility is distinct from morality. Items that provide utility may not always align with moral standards. It's essential to differentiate between the satisfaction a product brings and its ethical implications.

Concepts of Utility 

• Initial Utility: The initial utility is the satisfaction you get from the first piece of something you consume. For example, the joy you get from eating the first slice of bread is the initial utility. This joy is always positive.
• Total Utility: Total utility is the total satisfaction you get from consuming multiple units of a product. It's like adding up the satisfaction you get from each piece. For instance, if you eat four apples and get 10 units of satisfaction from the first, 8 from the second, 6 from the third, and 4 from the fourth, then your total utility is 10 + 8 + 6 + 4 = 28 units of satisfaction.
• Marginal Utility: Marginal utility is the satisfaction gained from consuming one additional unit of a product. It helps you understand how much more satisfaction you get from each extra piece you consume.
• Positive Marginal Utility: Positive marginal utility means that each additional unit of a product increases your satisfaction. It's like having another piece of chocolate when you're already enjoying it.
• Zero Marginal Utility: Zero marginal utility occurs when consuming an additional unit of a product doesn't increase your satisfaction anymore. You reach a point where more doesn't make you happier, like eating the tenth piece of pizza when you're already full.
• Negative Marginal Utility: Negative marginal utility happens when consuming more of a product actually decreases your satisfaction. It's like eating too much candy and feeling sick afterwards.

Measurement of Utility

Utility refers to the satisfaction or fulfillment that a commodity provides. It's a subjective concept not tied to ethics. Since utility is abstract, direct measurement is challenging. However, economists propose two methods for measuring utility, known as the Cardinal Approach and the Ordinal Approach.

Cardinal Approach to Utility

• The cardinal approach views utility in terms of the money a consumer is willing to give up when purchasing a commodity. This sacrifice of money is seen as a measure of utility. Pioneered by economists like Marshall, this approach uses money as a yardstick for utility.
• In this view, the more a consumer is willing to pay for a commodity, the higher the utility it provides. As a consumer acquires more units of a commodity, the additional units offer diminishing satisfaction. Hence, a consumer's utility for a commodity is assessed in monetary terms.
• For instance, if Mr. Mohan is ready to spend Rs. 18 on commodity X, Rs. 16 on commodity Y, and Rs. 14 on commodity Z, it implies that commodity X is more useful to him than commodity Y, and commodity Y is more valuable than commodity Z.

Ordinal Approach to Utility

• Ordinal economists like J.R. Hicks, R.G.D. Allen, FY. Edgeworth, and Vilfredo Pareto argue that utility is not quantifiable in cardinal numbers but in ordinal numbers like I, II, III, and so on.
• They highlight that utility is a subjective concept that varies with individuals and circumstances, making it unsuitable for numerical measurement.
• Unlike the cardinal approach, the ordinal approach focuses on ranking the utility derived from different commodities in order of preference.
• In this approach, commodities are compared based on the utility they provide, with the highest utility item being the most preferred.

Law of Diminishing Marginal Utility

The law of diminishing marginal utility explains that as we consume more of a product, the satisfaction or benefit we get from each additional unit decreases.

Assumptions of the Law

The law of diminishing marginal utility operates under certain assumptions to hold true. These include:

• Utility is measurable in numbers like 1, 2, 3, and so on.
• The consumer's income remains constant.
• The marginal utility of money stays the same.
• A reasonable amount of the product is consumed.
• Consumption of the product is continuous.
• The marginal utility of each product is independent of others.
• Each unit of the product is identical in quality and size.
• The consumer's tastes, habits, and preferences remain unchanged.
• There are no alterations in the price of the product or its substitutes.

Law of Equi-Marginal Utility 

The law of equi-marginal utility is a concept based on the law of diminishing marginal utility. It comes into play when a consumer aims to maximize satisfaction while consuming different units of various commodities with the resources at hand. This principle is often referred to as the law of substitution.

According to Prof. Alfred Marshall, when a person has a resource that can be utilized in multiple ways, they will distribute it among these uses in a manner that ensures the resource contributes equally to each use. If the resource had a greater value in one use compared to another, reallocating it would lead to increased overall benefit.

This law essentially suggests that a consumer can achieve maximum satisfaction by equalizing the marginal utility of all goods purchased in relation to their prices. By balancing the marginal utilities, consumers can optimize their satisfaction levels, a concept known as the law of equi-marginal utility.

Importance of the Law of Equi-marginal Utility

• Consumption: When a consumer allocates their income according to the law of equi-marginal utility, they distribute their spending across different goods in a way that the marginal utility derived from the last unit of currency spent on each good is equal. This ensures that the consumer maximizes their overall satisfaction from their income.
• Production: Producers aim to maximize profit. To do so, they should allocate resources among various factors of production in such a way that the marginal productivity of each factor is equal. This optimal allocation helps in achieving maximum profitability.
• Exchange: By following the law of equi-marginal utility, individuals will continue to exchange goods that provide higher utility for those that provide less until the marginal utility of all goods equalizes. Exchange will cease once this equilibrium is reached.
• Distribution: National income is distributed among the factors of production—land, labor, capital, etc.—in such a way that, over time, each factor receives a share proportional to its marginal productivity.
• Public Finance: In taxation, the finance minister applies this law by levying taxes so that the marginal sacrifice of each taxpayer is equal. This approach minimizes the overall burden on taxpayers. To achieve this balance, the finance minister may adjust or substitute one tax for another.