Jevon (1835 -1882) was the first economist who introduces the concept of utility in economics. According to him: "Utility is the basis on which the demand of an individual for a commodity depends upon".
The utility is defined as: "The power of a commodity or service to satisfy human want".
The utility is thus the satisfaction which is derived by the consumer from consuming the goods.
For example, the cloth has a utility for us because we can wear it. Pen has a utility who can write with it. The utility is subjective in nature. It differs from person to person. The utility of a bottle of wine is zero for a person who is non-drinker while it has a very high utility for a drinker.
The cardinal utility approach of consumer analysis makes the following assumption:
Law of diminishing marginal utility: This law states that when an individual consumer consumes more or more units of a commodity, the utility derived from each successive unit of the commodity goes of falling or decreasing or declining, but the total utility increases at a decreasing rate.
Law of substitution: This law states other thing being equal, the consumer gets maximum total utility from his given income, when he allocates his expenditure to the purchase of different goods in such a way that marginal utility derived from the last unit of the money spent on each item of expenditure tends to be equal.
It is also known as indifference curve analysis. An indifference curve is supposed to be a very important tool to analyze utility. They are used to represent an ordinal measurement of the tastes and preferences of the consumer and also to show how the consumer maximizes utility in spending income.
Assumptions of indifference curve
The concept of the indifference curve is based on following assumptions:
The concept of marginal rate of substitution is an important tool of indifference curve analysis of demand. It is the rate in which units of two goods are substituted or exchange to each other to maintain the same level of satisfaction. In other words, MRS of X for Y represents the amount of Y, which the consumer has to sacrifice or give up for the gain of one additional unit of X so that his level of satisfaction remains the same. In short, MRSXY is the ratio of the change in units of Y goods with the change in units of X goods. The MRS is given by the slope of the indifference curve.
Mathematically, MRSXY can be defined as follows:
Let us suppose that a consumer consumes only two goods X and Y, and they are substitutable. The utility function of consumer is given as
Q = f(x, y)……………….(i)
Now, let us suppose that the consumer substitutes X and Y such that his total utility remains the same. When he sacrifices or give up some units of Y, his stock of Y decreases by ΔY and he loses a part of his total utility, which is expressed as, -ΔY. MUY .... (ii)
On the other hand, the stock of X goods increases by ΔX as a result of the substitution of X for Y and he gains in total utility which is expressed as +ΔX. Mux ... (iii)
By rearranging the equations (ii) and (iii) simultaneously, we get,
-ΔY.MUY = ΔX.MUX
Therefore, -ΔY/ΔX = MUX /MUY .... (iv)
Based on equation (iv), we conclude that:
The expression -ΔY/ΔX reflects the slope of indifference curve (for MRSXY) when X good is substituted for Y good. But, when Y good is substituted for X good, ΔX/ΔY gives MRSXY.
Symbolically, slope of indifference curve
MRTSYX = -ΔX/ΔY = MUY /MUX
MRTSXY = -ΔL/ΔK = MUX/MUY
In the above figure, we can see that all the combinations of food and clothing which are A, B, D, E and G plotted on a graph. According to the figure, subsequent units of clothing substituting food go on decreasing with equal change (or increase) in units of food, MRSFC goes on decreasing. Various points are joined in order to form an indifference curve. All these combinations produce the same level of satisfaction to the consumer. This makes the consumer indifferent. It implies that MRS is diminishing. Due to an operation of a law of diminishing MRS, the indifference curve is convex to the origin. This means indifference curve slopes downwards from left to right as rectangular hyperbola).
Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan