Utility Analysis and Consumer Behaviour
Utility analysis explains how a consumer with a limited income distributes spending to maximise satisfaction. The exam tests the two cardinal laws, the ordinal indifference-curve alternative, and consumer's surplus.
Core rules
- Total utility (TU) is satisfaction from all units consumed; marginal utility (MU) is the addition from one more unit: MU = TUₙ − TUₙ₋₁.
- Law of diminishing marginal utility: as consumption rises, MU from each successive unit falls and can turn negative.
- TU is maximum when MU = 0; TU falls once MU becomes negative.
- Law of equi-marginal utility: the consumer maximises satisfaction when MUx/Px = MUy/Py = … = MUm.
- Indifference curves: an IC shows combinations giving equal satisfaction; it slopes downward, is convex to the origin, and ICs never intersect. Equilibrium occurs where the budget line is tangent to the highest attainable IC (MRS = Px/Py).
Worked example
A consumer has ₹30, with Px = ₹5 and Py = ₹3. At the current purchase, MUx = 30 and MUy = 15. MUx/Px = 30/5 = 6; MUy/Py = 15/3 = 5. Since 6 > 5, each rupee spent on X yields more satisfaction. The consumer buys more X and less Y until the ratios are equal - say MUx falls to 25 and MUy rises to 15: 25/5 = 5 and 15/3 = 5, which is equilibrium.
Traps that cost marks
- Saying TU is maximum where MU is maximum. MU peaks earlier; TU peaks at MU = 0.
- Writing that MU is always positive - over-consumption makes it negative.
- Confusing the cardinal approach (utility measurable in utils) with the ordinal approach (only ranking possible).
- Forgetting that consumer's surplus = total utility − total expenditure.