Utility and Cardinal Utility Theory

Utility

• Utility is the satisfaction derived from consuming goods or services, representing a commodity's ability to fulfill wants.
• Utility is subjective and varies among individuals based on needs and preferences.
• Utility changes with time, place, and quantity consumed.
• Utility differs from usefulness, focusing on the consumer's perception rather than the product's function.

Cardinal Utility Theory

• Utility is measurable using "utils," a hypothetical unit.
• Consumers aim to maximize satisfaction within their budget.
• Utility can be measured in monetary terms based on a consumer's willingness to pay.
• Marginal utility of money is assumed constant.
• Diminishing marginal utility applies: Each additional unit consumed provides less satisfaction.
• Total utility depends on quantities of all goods, not just one.

Measuring Utility

• Total Utility (TU): The total satisfaction from consuming a specific quantity of a good at a specific time. It initially increases, then plateaus, and eventually decreases.
• Marginal Utility (MU): The additional satisfaction from consuming one more unit. It decreases as consumption increases. Calculated as the change in total utility divided by the change in quantity.

Law of Diminishing Marginal Utility (LDMU)

• As consumption increases, the satisfaction from each additional unit decreases. This assumes other goods remain constant.
• The law describes a typical pattern, demonstrating declining utility with increased consumption.

Consumer Equilibrium

• Consumer equilibrium occurs when the marginal utility per birr (or other currency) spent on each good is equal.
• Consumer income/budget determines purchasing power.
• Rational consumers maximize utility with a limited budget.
• Consumer equilibrium (single commodity): Marginal utility of X equals the market price of X (MUx = Px).
• If MUx > Px, buy more X for increased utility.
• If MUx < Px, buy less X for increased utility.

New Information

• Utility is relative and not absolute. Different individuals derive varying utilities from the same good. Goods can also hold different utilities at different times and locations.
• "Utility" and "usefulness" aren't interchangeable. Usefulness relates to a product, whereas utility relates to a consumer's perception.
• Cardinal utility theory assumes utility can be measured numerically (e.g., in utils) or by a consumer's willingness to pay in monetary units.
• The primary goal of a rational consumer is satisfaction maximization within their budget constraints.
• Constant marginal utility of money is a cardinal utility assumption indicating each additional currency unit holds the same worth in utility.
• The total utility of many goods is calculated by the amounts of each good consumed (TU = f (X1, X2...Xn)).
• Consumption beyond a saturation point leads to negative marginal utility, decreasing overall satisfaction.