2 Utility can be measured in cardinal number 3 Marginal utility of money

2 utility can be measured in cardinal number 3

This preview shows page 1 - 3 out of 3 pages.

2. Utility can be measured in cardinal number 3. Marginal utility of money remains constant. (Whatever the level of consumers’ income, each unit of money has utility equal to 1). 4. Income of the consumer remains constant. 5. Diminishing marginal utility Let us suppose that the money income of the consumer is Rs. 18 which he spends on two goods X and Y. Let the per unit price of X and Y be Rs.2 and Rs 3, respectively. Now the equilibrium position is explained in the following table; The above table shows that the consumer reaches equilibrium when he purchases 3 units of X and 4 units of Y. Here the marginal utility of both X and Y are equal i.e. 8 utils. The total utility of 3 units of X would be 12+10+8= 30 utils and 4 units of Y would be 14+12+10+8 = 44 utils which gives total utility equals to 74 (=30+44) utils. This total utility represents maximum utility derived by the consumer out of his expenditure of Rs. 18. If the consumer spends his income on X and Y in any other manner, his/her total utility will be less than the maximum. This can be explained with help of figure below: 1 1 6 3 2 2 3 2 2 5 5 4 4 4 4 6 6 8 8 10 10 12 12 14 0 0 6 P N E2 E1 L M Y Y X X Q R Gain in utility Loss in utility Units MU x MU y MUx Px MUy Py 1 2 3 4 5 6 24 20 16 12 8 4 42 36 30 24 18 12 12 10 8 6 4 2 14 12 10 8 6 4
Image of page 1
The figure shows that consumer reaches equilibrium by purchasing 3 units of X and 4 units of Y because the marginal utilities of money spent on these goods are equal(E 1 N=E 2 R) to each other. In this situation the consumer gets maximum satisfaction or utility. Any other combinations will give less total satisfaction. Suppose a consumer buys one unit more of X and consequently one unit less of Y, this will lead to decrease in total utility. It is evident from the above figure that by purchasing one unit more of X the gain will be equal to LMNE 1 and by purchasing one unit less of Y the loss will be equal to PQRE 2 . In this case, the gain in utility(LMNE 1 ) is less than the loss of utility(PQRE 2 ). Thus, only 3 units of X and 4
Image of page 2
Image of page 3

You've reached the end of your free preview.

Want to read all 3 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture