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# 2013

## UNIT II (UTILITY ANALYSIS)

ENGINEERING ECONOMICS
Cardinal Utility Analysis, Meaning of Utility, Definitions of Utility, Features of Utility, Concepts of Utility, Relationship between Total Utility and Marginal Utility, Significance of the Difference between Total Utility and Marginal Utility, Measurement of Utility, Law of Diminishing Marginal Utility: Introduction, Definition, Assumptions, Exceptions, Importance Law of Equi-Marginal Utility: Introduction, Definition, Limitation, Practical Importance of Law of EMU. Questions and Answers

## UNIT II (UTILITY ANALYSIS)

UTILITY ANALYSIS
CARDINAL UTILITY ANALYSIS
In 19th century, economics from different countries of Europe put forward cardinal utility analysis in order to criticize the thoughts of classical economists like Adan Smith, Ricardo etc. The analysis was developed by Dupit, Gossen, Walras, Menger and Jevons etc. In 20th century Marshall and Pigou further elaborated cardinal utility analysis. According to this analysis utility can be measured in cardinal numbers like, 1,2,3,4,5 etc. Cardinal numbers are those numbers which can be added or subtracted. The term Util as a measure of Utility.

MEANING OF UTILITY
The term utility in Economics is used to denote that quality in a commodity or service by virtue of which our wants are satisfied. In other words, want-satisfying power of a good is called utility.

DEFINITIONS
1. According to Jevons, Utility refers to abstract quality whereby an object serves our purpose. 2. In the words of Hibdon, Utility is the quality of a good to satisfy a want. 3. According to Mrs. Robinson, Utility is the quality in commodities that makes individuals wants to buy them.

FEATURES
1. Utility is Subjective Utility is subjective because it deals with the mental satisfaction of a man. A thing may have different utility for different persons. Liquor has utility for a drunkard but for a person who is teetotaler, liqueur has no utility. Peasants of Haryana get very little utility from coffee whereas peasants of Kerala derive lot of utility from its consumption. Therefore, utility is subjective. 2. Utility is Relative Utility of a commodity never remains the same. It varies with time and place. Cooler has utility in the summer but not during the winter season. 3. Utility is not essentially useful A commodity having utility need not be useful. Liquor and cigarette are not useful, but if these things satisfy the wants of an addict then they have utility for him.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

4. Utility is Independent of Morality Utility has nothing to do with morality. Use of opium of liquor may not be proper from the moral point of view, but as these intoxicants satisfy wants of the opium-eaters and drunkards, they have utility.

CONCEPTS OF UTILITY
On the basis of the consumption of a commodity, there are two concepts of utility. (i) Total Utility (ii) Marginal Utility 1. Initial Utility The utility derived from the first unit of a commodity is called initial utility. Initial utility is the utility obtained from the consumption of the first unit of a commodity. Its always positive. 2. Total Utility The aggregate of utilities obtained from the consumption of different units of a commodity is called total utility. It is a function of the quantity of a commodity consumed and is expressed as: ( )

(TUx = Total utility of x is a function(f) of quantity of commodity x) In the words of Leftwitch, Total utility refers to the entire amount of satisfaction obtained from consuming carious quantities of a commodity. 3. Marginal Utility The concept of marginal utility was put forward by the emlnent economist Jevons. It is also called additional utility. The change that takes place in the total utility by the consumption of an additional unit of a commodity is called Marginal Utility. In the words of Chapman, Marginal utility is the addition made to total utility by consuming one more unit of commodity. Marginal utility can be measured with the help of the following equation:

MUnth = Marginal Utility of nth unit; Tn = total utility of n units; Tn-1 = Total utility of n-1 units. or Marginal utility can be (i)Positive (ii)Zero and (iii)Negative i) Positive Marginal Utility : If by consuming additional units of a commodity, total utility goes on increasing, then the marginal utility of these units will be positive. ii) Zero Marginal Utility: If the consumption of an additional unit of a commodity causes no change in the total utility, It means the marginal utility of the additional unit is zero.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

iii) Negative Marginal Utility: If the consumption of an additional unit of a commodity causes fall in total utility, it remains the marginal utility of that unit is negative.

## RELATIONSHIP BETWEEN TOTAL UTILITY (TU) AND MARGINAL UTILITY (MU)

When a consumer goes on to consume the units of a commodity continuously the marginal utility derived from the successive units of the commodity goes on to fall constantly while other factors are held constant. From the above statement regarding the consumer behavior the relationship between Total Utility (TU) and Marginal Utility (MU) is deducted as under: 1. 2. 3. 4. MU is the rate of change of TU. When the MU decreases, TU increases at decreasing rate. When MU becomes zero, TU is maximum. It is a saturation point. When MU becomes negative, TU declines

The standard quadratic form of the TU function is written as follows: TU = aQ - bQ2 and MU = dTU / dQ = a - 2bQ Slope of MU = dMU/dQ = -2b By taking the successive values of Q, the relationship between MU and TU is represented in the following schedule: Quantity 1 2 3 4 5 6 7 Total Utility 10 18 24 28 30 30 28 Marginal Utility 10 8 6 4 2 0 -2

With the help of above schedule the relationship between TU and MU is explained as: 1. In the above schedule MU decreases and TU increases at a decreasing rate up to 5th unit of commodity. 2. MU becomes zero at 6th unit and TU = 30 become maximum. 3. When MC becomes negative, the TU declines from 30 to 28 units at 7th units of a commodity. With the help of the above schedule the relationship between MU and TU can be represented in the diagram.

ENGINEERING ECONOMICS

2013

## UNIT II (UTILITY ANALYSIS)

1. In figure (2), MU curve moves downward having negative slope while in figure (1) TC curve, having negative positive slope moves upward but tendency to move is towards x-axis, which shows decreasing rate. 2. A point F in figure (2) MU curve cuts the s-axis at the 6th unit and TU curve has its maximum point F which is saturation point. 3. At 7th unit MU curve is below x-axis as in figure (2) and TU curve declines from point 'F' to 'G' as in figure (1). Mathematically MU = Change in TU / change in quantity consumed MU = TU / Q From point B to C MU = TU / Q =6/1 =6 This process remains upto point E and MU decreases. From E to point F MU = TU / Q =0/1 =0 It is the representation of zero marginal utility. While from point F to G MU = TU / Q -2 / 1 = -2 It is the representation of negative utility and total utility declines.

ENGINEERING ECONOMICS

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## SIGNIFICANCE OF THE DIFFERENCE BETWEEN TOTAL AND MARGINAL UTILITY

1. Paradox of Value : It is assumed that the price of a commodity was equal to its total utility. Thus goods which give more total utility should have more value, and goods which give less total utility should have less value. But it is not so in real life. One obtains more total utility from water than from diamonds, yet the price of water is far less than that of diamonds. This situation is called paradox of value. Jevons has explained this paradox with the help of the difference between marginal utility and total utility. Price of a commodity is determined by its marginal utility and not total utility. 2. Consumers Surplus : Sometimes a consumer is ready and willing to pay for a commodity much more price than its actual price. The difference between the two prices is called consumers surplus. The consumer is prepared to pay the price equivalent to the total utility that he obtains from all the units of the commodity but actually he pays the price equivalent to the marginal utility of the marginal unit of the commodity. Marginal Unit refers to the last unit that the consumer is prepared to buy. There will be a difference between the total amount of money paid on the basis of the total utility of a given number of units of commodity and the money actually paid on the bass of the marginal utility of the same number of units of the said commodity. This difference is called consumers surplus. The concept of consumers surplus is therefore based on the difference between total utility and marginal utility.

MEASUREMENT OF UTILITY
Utility is related to the feelings of mind. There is no instrument or standard to measure it. The economists have attempted to measure utility indirectly by two methods: 1. Measurement in terms of Money : In order to measure the utility in terms of money, it is estimated what amount of money a man is willing to pay for a thing. 2. Measurement in terms of Unit : Prof. Fisher has used the term, Util, as a unit for the measurement of utility. In this method, utility is expressed in utils. For example, if you get 10 utils of utility from a cup of tea, and your friend who is less fond of taking tea gets 5 utils of utility from a cup of tea, it shows that you are getting double the utility than your friend.

ENGINEERING ECONOMICS

2013

## LAWS OF UTILITY ANALYSIS

1. Law of Diminishing Marginal Utility 2. Law of Equi-marginal Utility

UTILITY ANALYSIS :

## LAW OF DIMINISHING MARGINAL UTILITY (DMU)

Dr. Marshall states this, law as follow: The additional benefit which a person derives from a given increase of his stock of anything diminishes with the growth of the stock that he has another words the law of DMU simply states that other things being equal, the marginal utility derived from successive units of a given commodity goes on decreasing. Hence the more we have of a thing; the less we want of it, because every successive unit gives less and less satisfaction.

Definitions
1. According to Marshall, The Additional benefit which a person derives from a given stock of a thing diminishes with every increase in the stock that he already has. 2. According to Chapman, The more we have of a thing, the less we want additional increments of it or the more we want not to have additional increments of it. 3. In the words of modern economist Prof. Boulding, As a consumer increases the consumption of any commodity, keeping constant the consumption of all other commodities, the marginal utility of the variable commodity must eventually decline. 4. According to Samuelson, As the amount consumed of a good increases, the marginal utility of the good tends to decrease. It is clear from the above definitions that at a given time when we go on consuming additional units of a commodity, the marginal utility from each successive unit of that commodity, other things being equal, goes on diminishing in relation to the preceding unit. It is this diminishing tendency of the marginal utility that has been enshrined in law of diminishing marginal utility. The law is explained with the help of following example Total Utility (TU) 3 14 16 16 14 Marginal Utility (MU) 8 6 2 0 (-) 2

## Units of commodity No. Of mangoes 1 2 3 4 5

It will be better to know some terms for understanding the law and they are. 1. Initial Utility is 8 : It is the utility of the initial or the first unit. In the table initial utility

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

2. Total Utility : In column 3 of the table, it gives the total utility at each step. For example it you consume on mango are total utility is 3, if you consume two mangoes, the total utility is 14. 3. Zero Utility : When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of zero utility. In our table, the TU after the 3rd unit is consumed is 16 and ar the 4th also it is 16. Thus, the 4th mango results in no increase. Thus is the point of zero utility. It is seen that the total utility is maximum when the MU is zero. 4. Marginal Utility : The addition to the total utility by the consumption of the last unit considered just worthwhile. The can be worked out by using following formula. 5. Negative Utility : It the consumption of a unit of a commodity is carried to excess, then instead of giving any satisfaction, it may cause dissatisfaction. The utility in such cases is negative. In the table given above the marginal utility of the 5th unit is negative.

ASSUMPTIONS

## THE ASSUMPTIONS OF THE LAW OF DMU ARE

1. All the units of the given commodity are homogenous i.e. identical in size shape, quality, quantity etc. 2. The units of consumption are of reasonable size. The consumption is normal. 3. The consumption is continuous. There is no unduly long time interval between the consumption of the successive units. 4. The law assumes that only one type of commodity is used for consumption at a time. 5. Though it is psychological concept, the law assumes that the utility can be measured cardinally i.e. it can be expressed numerically. 6. The consumer is rational human being and he aims at maximum of satisfaction.

EXCEPTIONS

## THE EXCEPTIONS TO THE LAW OF DMU ARE AS FOLLOWS

1. Hobbies : In case of certain hobbies like stamp collection or old coins, every addition unit gives more pleasure. MU goes on increasing with the acquisition of every unit. 2. Drunkards : It is believes that every does of liquor Increases the utility of a drunkard. 3. Miser : In the case of miser, greed increases with the acquisition of every additional unit of money. 4. Reading : Reading of more books gives more knowledge and in turn greater satisfactions.

## IMPORTANCE OF THE LAW OF DMU

1. Basic of economic law and concepts: This law of DMU forms the basis of law of demand, law of Equi-marginal utility, elasticity of demand etc. 2. Public finance : The Govt. can impose and justify progressive income tax on the ground of this law, as the income increases, the MU of income diminishes. 3. Businessmen : A businessman or producer can increase the sale of his product by fixing a lower price. Since consumers tend to buy more to equate MU with price, a producer can expect a rise in sale.

ENGINEERING ECONOMICS

2013

## UNIT II (UTILITY ANALYSIS)

UTILITY ANALYSIS : LAW OF EQUI-MARGINAL UTILITY (EMU)

This law of Equi-Marginal Utility is another fundamental principle of Economics. It is also known as law of substitution or law of Maximum satisfaction. We have already seen that human wants are unlimited whereas the means to satisfy these wants are strictly limited. It therefore becomes necessary to pick up the most urgent wants that can be satisfied with the money that a consumer has. In order to get maximum satisfaction out of the funds (money) we have, we carefully weigh the satisfaction obtained from each rupee that we spend. If we find that a rupee spend in one direction has greater utility than in another, we shall go non spending money, on the former ( first) commodity, till the satisfaction derived from the last rupee spent in the two cases is equal. In other words, we substitute some units of commodity of greater utility for some units of the commodity of less utility. The results of this substitution will be the MU of the former will fall and that of the latter will rise, till the two marginal utilities are equalized. That is why this law is called the laws of substitution or equi-marginal utility. This law has been illustrated with the help of table given below. Units 1 2 3 4 5 6 7 8 Marginal Utility of oranges 10 8 6 4 2 0 2 4 Marginal Utility of apples. 8 6 4 2 0 2 4 6

Suppose apples and oranges are the commodities to be purchased suppose we have go seven rupees to spend. Let us spend three rupees on oranges and four rupees on apples. The utility of 3rd unit of oranges is 6 and that of the 4th unit of apples is 2. As the MU of oranges is higher, we should buy more of oranges and less of apples. Let us substitute one orange for one apple so that we buy four oranges and three apples. Now the MU of both oranges and apples is the same i.e. 4. This arrangement yields maximum satisfaction. Thus total utility of 4 oranges would be 10+8+6+4=23 and of three apples 8+6+4=18 which gives a total utility of 46. The satisfaction given by 4 oranges and 3 apples of on one rupee each is greater than could be obtained by any other the total utility fiends less than 46. Thus, it can be concluded that we obtain maximum satisfaction when we equalize marginal utilities by substituting some unit of the more useful for the less useful commodity.

## LIMITATION OF THE LAW OF EQUI- MARGINAL UTILITY:

1. Ignorance : If a consumer is ignorant and blindly follows custom, he will may not make wrong use of money. 2. Inefficient organizer : The inefficient business organizer will final to achieve the best result from the land, labour and capital. That he employs. 3. Unlimited resources : When the resources are sample this law will be meaningless.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

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4. Hold of custom and fashion : It the purchase is strongly influence by customer and fashion he will not obtain maximum satisfaction. 5. Frequent changes in prices of different goods and services are occurred the observance of this law is difficult.

## PRACTICAL IMPORTANCE OF LAW OF EMU:

1. Consumption : A wise consumer acts on this law while arranging his expenditure and obtains maximum satisfaction. 2. Production : To obtain maximum net profit, he must substitute one factor of producing to another so as to have most economical combination. 3. Exchange : Exchange implies substitution of one thing to another and hence this law is important. 4. Distribution : It is on the principle of the marginal productivity that the share of each factor of production is determined. 5. Public finance : The Govt. is also guided by this law in public expenditure. The Govt. can expand its revenue (money) in such a way that it will secure maximum welfare of the people.

ENGINEERING ECONOMICS

2013

## UNIT II (UTILITY ANALYSIS)

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QUESTIONS
Question 1. Define the term utility. Distinguish between total utility and marginal utility and show that the concept of consumers surplus is based on this distinction. An economic term referring to the total satisfaction received from consuming a good or service. The term utility in Economics is used to denote that quality in a commodity or service by virtue of which our wants are satisfied. In other words, want-satisfying power of a good is called utility. 1. A consumer's utility is hard to measure. However, we can determine it indirectly with consumer behavior theories, which assume that consumers will strive to maximize their utility. Utility is a concept that was introduced by Daniel Bernoulli. He believed that for the usual person, utility increased with wealth but at a decreasing rate. 2. Since consumer demand for utilities does not change dramatically with a change in price, these companies are regulated by the state or provincial and federal governments. Differentiation between Total Utility & Marginal Utility Total Utility Marginal Utility Total utility is the total satisfaction obtained Marginal utility means an additional or from all units of a particular commodity incremental utility. Marginal utility is the change consumed over a period of time in the total utility that results from unit one unit change in consumption of the commodity within a given period of time Summing up total utility is the amount of Marginal utility, thus, can also be described as satisfaction (utility) obtained from consuming a difference between total utility derived from one particular quantity of a good or service within a level of consumption and total utility derived given time period. It is the sum of marginal from another level of consumption. utilities of each successive unit of consumption. ( ) MU= TU/Q Sometimes a consumer is ready and willing to pay for a commodity much more price than its actual price. The difference between the two prices is called consumers surplus. The consumer is prepared to pay the price equivalent to the total utility that he obtains from all the units of the commodity but actually he pays the price equivalent to the marginal utility of the marginal unit of the commodity. Marginal Unit refers to the last unit that the consumer is prepared to buy. There will be a difference between the total amount of money paid on the basis of the total utility of a given number of units of commodity and the money actually paid on the bass of the marginal utility of the same number of units of the said commodity. This difference is called consumers surplus. The concept of consumers surplus is therefore based on this distinction.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

Question 2.

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What is consumers equilibrium? Explain its determination with the hel p of utility analysis.

When consumers make choices about the quantity of goods and services to consume, it is presumed that their objective is to maximize total utility. In maximizing total utility, the consumer faces a number of constraints, the most important of which are the consumer's income and the prices of the goods and services that the consumer wishes to consume. The consumer's effort to maximize total utility, subject to these constraints, is referred to as the consumer's problem. The solution to the consumer's problem, which entails decisions about how much the consumer will consume of a number of goods and services, is referred to as consumer equilibrium. Determination of consumer equilibrium. Consider the simple case of a consumer who cares about consuming only two goods: good 1 and good 2. This consumer knows the prices of goods 1 and 2 and has a fixed income or budget that can be used to purchase quantities of goods 1 and 2. The consumer will purchase quantities of goods 1 and 2 so as to completely exhaust the budget for such purchases. The actual quantities purchased of each good are determined by the condition for consumer equilibrium, which is

Question 3.

Explain the Law of Diminishing Marginal Utility. Discuss the importance and limitations of this law.

A law of economics stating that as a person increases consumption of a product - while keeping consumption of other products constant - there is a decline in the marginal utility that person derives from consuming each additional unit of that product. IMPORTANCE OF DMU: 1. Basic of economic law and concepts: This law of DMU forms the basis of law of demand, law of Equi-marginal utility, elasticity of demand etc. 2. Public finance : The Govt. can impose and justify progressive income tax on the ground of this law, as the income increases, the MU of income diminishes. 3. Businessmen : A businessman or producer can increase the sale of his product by fixing a lower price. Since consumers tend to buy more to equate MU with price, a producer can expect a rise in sale. LIMITATION OF DMU: 1. Desire of Money : This law is not applicable in case of money with an increase in wealth man wants to get more and more. 2. Desire of knowledge : Some experts say that man wants to get more and more knowledge so the law cannot be applied in this case. 3. Use of liquor : With the additional use of liquor like wine marginal utility also goes on increasing. 4. Personal hobby : In case of hobby also this law cannot operate. For example, as the collection of tickets increases, its utility also increases.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

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5. Fashion : Utility also depends upon fashion. If the fashion of any commodity changes, its utility drops down to zero. On the other hand if fashion exists then utility increases.

Question 4.

Define the Law of Equi-Marginal Utility. Also give its importance and limitations.

It is the desire of every consumer that he wants to get maximum satisfaction from his limited resources. He can solve this problem if he spends his income in such a way that the last rupee spent on each item gives him the same amount of satisfaction. It is called the law of equi-marginal utility. Every consumer will substitute the more useful for the less useful thing. This law is also known as the law of substitution. It is called the law of Equi-Marginal Utility because it is only law by which the marginal utilities have been equalized through the process of substitution. This law can be explained with the help of following schedule, assuming that our consumer has only Rs. 5/- to spend. Further it is assumed that there are two commodities Apple and Orange. PRACTICAL IMPORTANCE OF LAW OF EMU: 1. Consumption : A wise consumer acts on this law while arranging his expenditure and obtains maximum satisfaction. 2. Production : To obtain maximum net profit, he must substitute one factor of producing to another so as to have most economical combination. 3. Exchange : Exchange implies substitution of one thing to another and hence this law is important. 4. Distribution : It is on the principle of the marginal productivity that the share of each factor of production is determined. 5. Public finance : The Govt. is also guided by this law in public expenditure. The Govt. can expand its revenue (money) in such a way that it will secure maximum welfare of the people. LIMITATIONS OF THE LAW OF EQUI-MARGINAL UTILITY 1. Immeasurable concept : the concept of utility is immeasurable so it is very difficult to behave according to the law. 2. Carelessness : sometimes due to ignorance people do not obtain the maximum advantage by equating the marginal utilities. 3. Indivisible units : if the unit of expenditure is indivisible then this law will not operate. 4. Customs : people are slave of customs and traditions, so they use the goods like gold even there is less utility. 5. Freedom of choice : if there is no perfect freedom to choose between various commodities, then the law will not operate.

ENGINEERING ECONOMICS

2013

## UNIT II (UTILITY ANALYSIS)

Question 5. Explain the Law of Maximum Utility.

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The process or goal of obtaining the highest level of utility from the consumption of goods or services. The goal of maximizing utility is a key assumption underlying consumer behavior studied in consumer demand theory. Consumers are assumed to make choices, especially concerning the purchase of goods, such that they obtain the highest possible level of satisfaction. Utility maximization can be achieved at the peak of the total utility curve.

Question 6.

## What is meant by utility analysis? Give its main criticism.

Utility analysis is a quantitative method that estimates the dollar value of benefits generated by an intervention based on the improvement it produces in worker productivity. Utility analysis provides managers information they can use to evaluate the financial impact of an intervention, including computing a return on their investment in implementing it. The concept of utility was originally introduced by Brogden (1949) and Brogden and Taylor (1950) and further developed by Cronbach & Gleser (1965). The concept has been researched and extended by Cascio (1982); Schmidt, Hunter, and Pearlman (1982); and Reilly and Smither (1983), among others. It was introduced as a method for evaluating the organizational benefits of using systematic procedures (e.g., proficiency tests) to improve the selection of personnel but extends naturally to evaluating any intervention that attempts to improve human performance. Basic Assumptions The first assumption of utility analysis is that human performers generate results that have monetary value to the organizations that employ them. This assumption is also the basis on which people claim compensation for the work they do. The second assumption of utility analysis is that human performers differ in the degree to which they produce results even when they hold the same position and operate within like circumstances. Thus, salespersons selling the same product line at the same store on the same shift will show a variation in success over time with a few doing extraordinarily well, a few doing unusually poorly, and most selling around the average amount for all salespersons. This assumption is broadly supported in common experience and in research. It is, for example, the basis on which some performers demand and receive premium compensation. Criticism of Utility Analysis 1. Utility is Subjective: Utility is a subjective concept. It relates to mans psychology. It is not possible to be objective about it. But the analysis of consumers demand based on its is objective. 2. Cardinal measurement of utility is not possible: Utility cannot be measured in cardinal numbers like integers. As such, Utility derived from different quantities of the goods can neither be added not subtracted. Marshall sought to measure marginal utility indirectly in terms of money. But according to Pigou it is not possible to measure marginal utility indirectly in terms of money, because money can, at the best, measure the intensity of demand for a good. It cannot measure the actual satisfaction.

ENGINEERING ECONOMICS

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## UNIT II (UTILITY ANALYSIS)

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3. Every commodity is not an independent commodity: The analysis is based on the assumption that every commodity is an independent commodity. In real life, we find that utility of a commodity is very much dependent upon the utility of other commodities. No commodity is an independent commodity. Consumers behavior cannot therefore be precisely measured through utility analysis. 4. Marginal utility cannot be estimated in all conditions: Utility analysis is based on the concept of marginal utility. Marginal utility of only those commodities can be measured which are divisible. But it has already been pointed out that the divisions of some commodities like T.V., refrigerator etc. is not possible, and as such there marginal utility cannot be measured. 5. Marginal utility of money does not remain constant: The other assumption of utility analysis is that marginal utility of money remains constant. This assumption is also not real. As the quantity of money with a person increases, its marginal utility diminishes and as the quantity of money decreases, its marginal utility increases. 6. Too many assumptions: Practicability of any theory is based on its assumptions. Cardinal utility analysis is hemmed with too many assumptions. Many of its assumptions, like cardinal measurement of utility, independent commodities etc. are unrealistic and impracticable. Indifference curve analysis gives a more comprehensive explanation of consumers equilibrium without all these assumptions. 7. No division of Price effect between Income effect and Substitution Effect: Utility analysis does not divide price effect into income effect and substitution effect. It does not indicate that when as a result of change in price, demand changes, how much of this changed demand is due to change in real income, and how much due to substitution of cheap good for the expensive one. 8. Consumer is regarded as a computer: It considers consumer as a computer. According to this analysis while spending his money, a consumer always compares the amount of gain he will have by way of utility of the commodity purchased with the loss that he will have to suffer by way of sacrifice of the money spent. But in real life none of us is so calculating. 9. Utility analysis breaks down in an Under-developed Planned Economy: Utility analysis is based on the assumption that the taste of the consumer remains unchanged. It may be so for a short period only; but in long period, consumers taste undergoes a change. In a planned economy long term plans are formulated keeping in view the fact, that in the longrun demand of the consumer will change with change in his taste. Utility analysis has failed to comprehend this reality. 10. It does not explain Giffens Paradox: Cardinal Utility analysis does not explain Giffins paradox. It has no answer to explain as to why the demand curve of many inferior goods slopes upward from left to right. In other words, why does demand extend with rise in price and why does demand contract with fall in price?

ENGINEERING ECONOMICS

2013