Utility Analysis

Utility Analysis

Utility analysis investigates consumer behavior, especially market purchases, is based on the satisfaction of wants and needs generated from the consumption of a good. It is a subset of consumer demand theory that analyzes consumer behavior and market demand using total utility and marginal utility. The key principle of utility analysis is the law of diminishing marginal utility, which offers and explanation for the law of demand and the negative slope of the demand curve.

Total utility: It is the measure of the total satisfaction of wants and needs obtained from the consumption of the good or service

Marginal utility: It is the additional utility, or extra satisfaction of wants and needs, obtained from the consumption or use of and additional unit of a good or service

Law of diminishing utility: It states that,” the more of a good a person consumes per period, the smaller the increase in total utility from consuming one more unit, the other things constant”.

Assumptions:

• Consumers seek to maximize satisfaction from the limited income.
• Utility is cardinally measurable
• Marginal utility of money remains constant
• Diminishing marginal utility
• Consumption to be continuous
• No change in tastes, preferences , price of the commodity

   If a good is free, the consumption gets increased as long as marginal utility is positive. At any level of consumption, marginal utilities sum to total utility. Once a consumer is in equilibrium, there is no way to increase utility by reallocating the budget. In equilibrium, the last rupee spent on each good yield the same marginal utility.  

Indifference curve: Represents various combination of goods that provide the same level of satisfaction to the consumer

Marginal rate of substitution: The rate at which a consumer is ready to give up one commodity in exchange for another commodity while maintaining the same level of satisfaction. It is represented by the slope at any given point on the indifference curve.

Properties of Indifference curve:

•  Indifference curve are negatively sloped
• A higher indifference curve represents a higher level of satisfaction
• Indifference curve cannot intersect each other
• They are convex to the origin

Exceptions: When the goods are easy to substitute for each other, the indifference curves are less convex; when the goods are difficult to substitute, the indifference curves are very convex.