CENTRAL UNIVERSITY OF SOUTH BIHAR

ASSIGNMENT ON-
SCHOOL RECORD

SUBMITTED BY:-
NAME:- PRAWEEN KUMAR
COURSE:- B.Sc.B.Ed
SEMESTER:-8th
ENROLLEMENT NO:-CUB1311114023
Acknowledgement
I would like to express my special
thanksto myProff. Mr. T Patra, who
gave me the golden opportunity to
work on this wonderful project.
I would like to again thank my Proff.
for his guidance which play great role
in completing this project.
At last I would like to thank all person
who helped me a lot in finalizing this
project.
 CONTENT

TOPICS
Introduction
Application
Function of utility

Total Utility
Marginal Utility
Cardinal Utility
Ordinal utility
Law of diminishing marginal utility
Law of Diminishing Marginal Utility Graph
Example of Law of Diminishing Marginal Utility
Application and Importance of the Law of Diminishing
Marginal Utility
Principle of Equi-Marginal Utility
CONCLUSION
Introduction

In economics, utility is a measure of preferences over some set of goods

(including services: something that satisfies human wants); it represents
satisfaction experienced by the consumer of a good. The concept is an important
underpinning of rational choice theory in economics and game theory: since one
cannot directly measure benefit, satisfaction or happiness from a good or
service, economists instead have devised ways of representing and measuring
utility in terms of measurable economic choices. Economists have attempted to
perfect highly abstract methods of comparing utilities by observing and
calculating economic choices; in the simplest sense, economists consider utility
to be revealed in people's willingness to pay different amounts for different
goods.

Applications

Utility is usually applied by economists in such constructs as the indifference

curve, which plot the combination of commodities that an individual or a
society would accept to maintain a given level of satisfaction. Utility and
indifference curves are used by economists to understand the underpinnings
of demand curves, which are half of the supply and demand analysis that is used
to analyze the workings of goods markets.
Individual utility and social utility can be construed as the value of a utility
function and a social welfare function respectively. When coupled with
production or commodity constraints, under some assumptions these functions
can be used to analyze Pareto efficiency, such as illustrated by Edgeworth
boxes in contract curves. Such efficiency is a central concept in welfare
economics.
In finance, utility is applied to generate an individual's price for an asset called
the indifference price. Utility functions are also related to risk measures, with
the most common example being the entropic risk measure.
Function of utility or utility function
In economics,utility function is an important concept that measures
preferences over a set of goods and services. Utility is measured in units called
utils, which represent the welfare or satisfaction of a consumer from consuming
a certain number of goods. Because satisfaction or welfare is a highly abstract
concept, economists measure utility in termsof revealed preferencesof revealed
preferences by observing consumer choices and creating an ordering of
consumption baskets from least desired to the most preferred. Economists create
a parametric functional form for the utility function based on the assumption of
observed consumer behavior, with the amount of goods as variables and certain
fixed parameters. After that, utility is calculated by substituting certain
numerical values for the consumption of goods in the utility function.

In economics, the utility function measures welfare or satisfaction of a

consumer as a function of consumption of real goods, such as food, clothing and
composite goods rather than nominal goods measured in nominal terms. Utility
function is widely used in choice rational theory toanalyze humanbehavior.

There are various type of utility as

Total Utility

Total utility (TU) is defined as the total amount of satisfaction that a person can
receive from the consumption of all units of a specific product or service. Using
the example above, if a person can only consume three slices of pizza and the
first slice of pizza consumed yields 10 utils, the second slice of pizza consumed
yields 8 utils and the third slice yields 2 utils, the total utility of pizza would be
20 utils.

TU can be infinite. Its upper boundary is set by the total number of a good or
service available for consumption by a consumer.
Marginal Utility
Marginal utility (MU) is defined as the additional utility gained from the consumption
of one additional unit of a good or service. Using the same example, if the utility of
the first slice of pizza is 10 utils and the utility of the second slice is 8 utils, the MU of
eating the second slice is 8 utils. If the utility of a third slice is 2 utils, the MU of
eating that third slice is 2 utilis

Cardinal Utility
The cardinal utility approach is propounded by neo-classical economists, who
believes that utility is measurable , and the customer can express his
satisfaction in cardinal or quantitative numbers such as 1,2,3,and so on.
Ordinal utility
In economics an ordinal utility function is a function representing the preference
of an agent on an ordinal scale .the ordinal utility theory claim that it is only
meaningful to ask which option is better than the other ,but it is meaningless to
ask how much better it is or how good it is.

After the discussion of types of utility I an going to explain the law of

diminishing marginal utility

Law of diminishing marginal utility

An important tenet of cardinal utility analysis relates to the behaviour of
marginal utility . This familiar behaviour of imaginal utility has been stated in
the law of diminishing marginal utility according to which marginal utility of
good diminishes as an individual consumer more units of a good. In other word
as consumer takes more units of good , the extra utility or satisfaction that he
derives from an extra units of good is going on falling.

The law of diminishing marginal utility means that the total utility increases
at decreasing rate .

Marshall who has been the famous exponent of the cardinal utility analysis has
stated the law of diminishing marginal utility as follows:

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.

This law is based upon two important facts. First , while the total wants of man
are virtually unlimited , each single wants is satiable . Therefore , as an
individual consumer more and more units of good, intensity of his wants of
goods go on falling and a point is reaches where the individual no longer wants
any more units of good. That is, when saturation point is reached , marginal
utility of good became zero.

The second fact on which law of diminishing marginal utility is based is that
the different goods are not perfect substitutes for each other in the satisfaction of
various particular wants. When an individual consumer more and more units of
goods, the intensity of his particular wants for goods are not perfect substitution
for each other in the satisfaction of various particular want for the goods
diminishes but if the units of that goods could be devoted to the satisfaction of
other wants and yielded as much satisfaction as they did initially in the
satisfaction of first want, marginal utility of good would not have diminished.

It is obvious from above that the law of diminishing marginal utility describes a
familiar and fundamental tendency of human nature.

Law of Diminishing Marginal Utility Graph

We can see the graph that shows that as more goods or goods are consumed,
their marginal utility decreases becoming in some cases negative (the marginal
utility in green color can be seen in the image).
This theory is applied more in capitalist societies where the accumulation of a
good or goods is a common element of these and allows identifying marginal
utilities that diminish with the passage of time forming utility curves with
negative slope.

Example of Law of Diminishing Marginal Utility

Suppose a person who does not have shoes to go to work and decides to buy
new ones. This person has a positive initial marginal utility. As you wear your
shoes you will be buying more and more and your degree of satisfaction will be
less because of the accumulation of more goods. Therefore, the marginal utility
will become constant in time and then become decreasing. In a
society capitalist , this theory is very common since society tends to
accumulation and oblivion of many goods that are purchased.

Another example can be found in a child when they buy toys, over time,
because they have more toys, stop playing with antique toys losing their interest
in playing with them. In this case, the marginal utility does not refer to a
material value and their economic quantification, but rather the ability
of consumption and its assessment.

Law that states that the marginal utility of a good for each consumer decreases
when each extra unit of the good consumed causes a smaller increase in its
usefulness.

Diminishing Marginal Utility and Demand

In the middle of the nineteenth century, a series of ideas appeared in several
European countries, which, apart from historical and institutional
considerations, but also forms of organization of production, proposed to
explain the value of goods from the individual psychology. Put another way, the
objective conception of value built on production costs, particularly in labor
was abandoned in favor of a subjective approach based on consumer
behavior, determined by its tastes and its resources.

Application and Importance of the Law of Diminishing Marginal

Utility

We have seen how the law of diminishing marginal utility helps in

understanding the tendency of marginal utility to fall with increase in intake or
consumption of a commodity by a consumer. Apart from that we have also gone
through the assumptions, exceptions as well as limitation of this law. Do you
think such an important law could be understood without getting a sense of how
it is applicable? Isnt it better to understand the importance of this important
economic law? That is what we are going to see in this write-up. The law of
diminishing marginal utility has both theoretical as well as practical
applications. Let us see what they are.

Serves as foundation for other economic laws: We have mentioned earlier that
the law of demand could be understood on the basis of the law of DMU. The
derivation of the law of demand has its base in the law of diminishing marginal
utility as the inverse relation between the quantity demanded and price can be
brought out through this law. It thus helps us in getting a sense as to why the
demand curve has downward sloping nature. Similarly this law is useful
understanding other concepts like the consumer behavior as well as equilibrium
when we are talking about a single want at time.
Helps in business: Pricing of the products is one of the most important business
decisions. We understand that marginal utility of a product diminishes with the
increase in consumption or increase in the stock. This helps the producers in
framing the prices because when consumers need to attain the equilibrium then
they may purchase more of the commodity to reduce the marginal utility. The
manufacturers thus could reduce the price in order to encourage sales. It simply
means that the consumers may try to connect the marginal utility and price of
the commodity and this is the reason why more quantities are bought at reduced
prices.

Scheduling purchases: The law of DMU helps in scheduling purchases.

Through the law of diminishing returns a person may understand how to
schedule the purchases since this law gives an understanding as to when the
point of satiety or maximum satisfaction can be attained. This simply means that
this law enables a person to know by consumption of how much units greatest
satisfaction is attained and through this purchases can be planned accordingly.
This also helps in utilizing the incomes efficiently.

Public Finance: The law of DMU is helpful in this area too. The taxation
policy may be devised in such a way that it is progressive in nature meaning the
higher taxes for the rich. This way the government may be able to raise more
funds since usually with rise in incomes the marginal utility of money may
witness a fall. A tax policy which taxes the affluent more and the people falling
in the lower income group less may thus be beneficial in the area of public
finance. Income inequalities could be dealt with by taxing the goods which are
enjoyed by the affluent people more. Government may devise the fiscal policies
with the help of the law of diminishing marginally utility. So how can his be
done? Well, as we understand the value of money may be different for different
people. Here we are talking in terms of additional money, as for an affluent
individual the value of additional money is trivial but this is not the case for an
underprivileged person. On the basis of the value of money fiscal policy may be
formulated.
 Welfare measures could be understood: Welfare measures are meant to create
welfare policies for the deprived people. As we have seen in the point of public
finance the funds that are generated by taxing the affluent people at higher level
could be utilized for the welfare of the people in the form of free education and
health facilities for the underprivileged as well as food subsidies for them.

Paradox of value could be understood: A commodity may be understood with

respect to value-in-use and value-in-exchange. Let us try to get a sense of both
these terms. The usefulness of the product is termed as value in use. What is
value in exchange then? It is the value rate of one product with respect to other.
These both terms are explained by paradox of value. Paradox of value helps in
understanding the variation between these two terms. These are usually
explained with the help of commodities like water and salt with respect to those
like diamonds. We certainly cannot doubt the utility of water and hence its value
in use is very high. It means that the total utility of water is higher. But what
about the value in exchange for water? The value in exchange is not that high or
we could also say that it is trivial. This is due to the marginal utility, as marginal
utility of water is very less and also it reduces extremely quickly. Now let us see
the situation of diamonds. For a commodity like diamond the marginal utility is
too high and it also reduces slowly but total utility is not as high as that of water.
So this means for diamonds value in exchange is very high and the value in use
is quite low. So here we have seen how marginal utility of a product determines
the value in exchange. Another factor in this situation is the availability of the
products. Diamonds we know is a scarce commodity and this is not the case
with water. Marginal utility indicates the appeal or the intensity of the want. For
diamond the marginal utility is very high showing the high degree of intensity
of the want as the availability is scarce and hence even at higher price these are
bought by the people. But for water, it is available in larger quantities which
makes marginal utility quite low and hence is also priced low.

Principle of Equi-Marginal Utility

Principle of equi-marginal utility occupies an important place in the marginal
utility analysis. It is through this principle that consumers equilibrium is
explained. A consumer has a given income which he has to spend on various
goods he wants.
Now, the question is how he would allocate his money income among various
goods that is to say, what would be his equilibrium position in respect of the
purchases of the various goods. It may be mentioned here that consumer is
assumed to be rational, that is, he coldly and carefully and substitutes goods
for one another so as to maximize his utility or satisfaction.

Suppose there are only two goods X and Y on which a consumer has to spend a
given income. The consumers behavior will be governed by two factors: first,
the marginal utilities of the goods and secondly, the prices of two goods.
Suppose the prices of the goods are given for the consumer.

The law of equi-marginal utility states that the consumer will distribute his
money income between the goods in such a way that the utility derived from the
last rupee spend on each good is equal. In other words, consumer is in
equilibrium position when marginal utility of money expenditure on each goods
is the same.

Now, the marginal utility of money expenditure on a good is equal to the

marginal utility of goods divided by the price of the goods.

In symbols:
MUe= MUZ/PZ
Where MUe is marginal utility of money expenditure and MU z is the marginal
utility of the goods X and Pz is the price of X. The law of equi-marginal utility
can, therefore, be stated thus: the consumer will spend his money income on
different goods in such a way that marginal utility of each good is proportional
to its price. That is, consumer is in equilibrium in respect of the purchases of
two goods X and Y when
MUz/ PZ = MUz / PZ
Now, if MUz / PZ and MUy/ PZ are not equal and MUz / PZ -is greater than MUz
/ PZ then the consumer will substitute goods X for goods Y. As a result of this
substitution the marginal utility of goods Y will rise. The consumer will
continue Substituting goods X for goods Y till MUy/ PZ becomes equal to MUy /
PZ When MUZ/ PZ becomes equal to the Muy/ PZy consumer will be in
equilibrium.
But the equality of MUZ / PZ with MUy/PZ can be achieved not only at one level
but at different levels O expenditure. The question is how far a consumer goes
on purchasing the goods he wants. This is determined by the size of his money
expenditure. With a given expenditure a rupee has a certain utility for him: this
utility is the marginal utility of money by him.
Since the law of diminishing marginal utility applies to money also, the greater
his money expenditure the consumer will go on purchasing goods till the
marginal utility of expenditure on each good becomes equal to the marginal
utility of money to him.

Thus, the consumer will be in equilibrium when the following equation holds
good:
MUZ,/PZ = MUY/Py = MUm
If there are more than two goods on which the consumer is spending his
income, the above equation must hold good for all of them.

Let us illustrate the law of equi-marginal utility with the aid of an arithmetical
table given as follows:

Table-Marginal Utility of Goods X and Y:

Units MVZ (units) MUY (Units)
1 20 24

2 18 21

3 16 18

4 14 15

5 12 9

6 10 2

Let the prices of goods X and Y be Rs. 2 and Rs. 5 respectively.

Reconstructing the above table by dividing marginal utilities of X (MU Z) by Rs.

2 and marginal utilities of Y (MUY) by Rs. 3 we get:
Table-Marginal Utility of Money Expenditure:
Units MUZ/PX MUY/PY
1 10 8

2 9 7

3 8 6

4 7 5

5 6 3

6 5 1

Suppose, the consumer has Rupees 19 with him to spend on the two goods X
and Y. By looking at the table it is clear that MU Z/PX is equal to 6 units when the
consumer purchases 5 units of goods X; and MUZ/PX is equal to 6 units when he
buys 3 units of goods y. Therefore, consumer will be in equilibrium when he is
buying 5 units of good X and 3 units of goods Y and will be spending (Rs. 25+
Rs. 33) = Rs.19 on them.
The law of equi-marginal utility can be graphically illustrated in another way
also. Consider Figure 4. Suppose a consumer has got OO amount of money
income which he has to spend on two goods X and Y. In this figure, curve AB
shows the marginal utilities of successive rupees spent on commodity X with O
as the point of origin. CD shows the marginal utilities of successive rupees
spent on commodity Y with O as the origin.
It is worth noting that we read the number of rupees spend on commodity X
from left to right and read the number of rupees spent on commodity y from
right to left. It will be seen from this figure that the two curves AB and CD
showing the diminishing marginal utility of rupees spent on X and Y
respectively, intersect at point E.

That is, at point E marginal utility of rupee spent on commodity X (MU) is

equal to the marginal utility of rupee spent on commodity Y (MU y). Thus, when
OM amount of money is being spent on commodity x and the remaining OM is
being spent on commodity Y, marginal utility of a rupee spent on these two
commodities in the same.
This represents consumers equilibrium in respect of the expenditure of a given
amount of money income OO on the two commodities X and Y and in this
position consumer will be getting maximum satisfaction from the given amount
of money income, now, it can be proved that if we spend a little more amount
on one commodity and the same amount of money less on the other, the
satisfaction will decline.

Thus, if a consumer spends MN amount of money more on commodity X and

therefore MM amount of money less on commodity Y, his gain in satisfaction
will be equal to MEHM and his loss in satisfaction will be equal to MEHN. It is,
thus, clear that the loss in satisfaction is greater than the gain in satisfaction by
spending MN amount of money more on X and the same amount of money less
on Y. We therefore, conclude that the consumer derives maximum satisfaction
when he is allocating money expenditure among different commodities in such
a way that the marginal utility of money spent on each of them is the same.

The above equimarginal condition for the equilibrium of the consumer can be
stated in three ways.

(1) A consumer is in equilibrium when he equalizes weighted marginal utilities

of all goods, that is, when the marginal utility of each good weighted by its price
is equal.

In other words, when MUZ/ Pz = MUY/Py = MUN /PN = MUm

(2) A consumer is in equilibrium when he equalises the ratios of marginal
utilities of goods with the ratio of corresponding prices for each pair of goods
consumed, that is, when MUZ/PZ = PZ/ Py and MUY/MU =Py /PZ and so forth
(3) Since MUZ/PZ measures the marginal utility of a rupees worth of each
good consumed at the given prices, consumer can be said to be in
equilibrium when the marginal utility of a rupee spent on each good
purchased in equal. Marginal utility of a rupee spent on a good means the
marginal utility of a rupees worth of the good.
Criticisms against Marshalls Utility Analysis
The following points highlight the three major criticisms against Marshalls
utility analysis. The criticisms are: 1. Unrealistic Assumptions 2. MU of Money
can never be Constant 3. No Formal Distinction between Income and
Substitution Effect.

Unrealistic Assumptions:

Marshalls utility analysis is based on some unrealistic assumptions. For

instance, Marshall assumed that utility derived from a commodity can be
measured in cardinal numbers. But, modern economists like J. R. Hicks and R.
G. D. Allen had suggested that utility, being a psychological concept, can never
be measured in cardinal numbers.

Actually, there is no measuring rod to measure utility derived from the

consumption of a commodity. According to them, utility can be measured in
ordinal numbers. This means that the consumer is capable of comparing
different levels of utility.

A consumer can say that a particular commodity gives him a higher or lower
level of satisfaction than another commodity. Of course, he cannot quantify the
level of satisfaction. As the law of demand is based on Marshalls utility
analysis, the explanation of the law of demand seems to be inaccurate.

MU of Money Can Never be Constant:

Marshalls assumption of constant marginal utility of money is another

unrealistic assumption. And this is the most crucial assumption of the utility
theory. According to Marshall, utility from a good can be measured in terms of
money.
To measure utility (in cardinal numbers) in terms of money, marginal utility of
money must remain invariant. But, like commodities, marginal utility of money
also diminishes when stock of money rises. If it is so, measurement of utility in
terms of money seems to be irrational.

No Formal Distinction between Income and Substitution Effect:

Because of the constancy in the marginal utility of money, Marshall could not
distinguish between income effect and substitution effect of a price change. We
know that a change in the price of a commodity results in two types of changes
one is the income effect and another is the substitution effect. Marshall
considered only the substitution effect and ignored the income effect.

Because of constancy in the marginal utility of money, Marshall ignored the

income effect. As Marshall considered only substitution effect, his demand
curve is always negative sloping. In other words, Marshall could not explain
Giffen Paradox for which the law of demand does not hold.

Because of these criticisms, Marshallian utility analysis failed into disrepute. In

the 1930s Hicks and Allen introduced an alternative theory known as ordinal
utility theory or indifference theory which is an improvement over Marshalls
cardinal utility theory.

CONCLUSION
By studied the topic we can say that utility is an important concept of
economics which talk about the satisfaction of consumer . if any new good
came in market and consumer buy that goods and use them the consumer .By
the help of utility we will measure the satisfaction of consumer by help of
utility.
At we can conclude that the utility is an economic term introduced by Daniel
Bernoulli referring to the total satisfaction received from consuming a good or
service. The economic utility of a good or service is important to understand
because it will directly influence the demand, and therefore price, of that good
or service. A consumer's utility is hard to measure, however, but it can be
determined indirectly with consumer behavior theories, which assume that
consumers will strive to maximize their utility.