"Utility is a theoretical concept that cannot be observed or measured in the real world. Hence, it has no practical value in decision analysis."

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Assignment

“Utility is a theoretical concept that cannot be observed or measured in the real world. Hence, it has no practical value in decision analysis.”

 Module: Managerial Economics

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Contents

Definition of utility…………………………………………………….3

Total and marginal utility……………………………………………4

Graphic description of total and marginal utility………………..6

The utility of different goods and services, and the balance of the consumer………………………………………………………….8

Application of the theory of utility………………………..............9

Indifference curves………………………………………………….14

Uncertainty and the consumer……………………………………17

Definition of utility

“The assumption of rational economic behavior leads logically to a further assumption fundamental to economic theory, that economic agents decide their market plans so as to maximize some target, objective or goal believed consistent with self interest. In demand theory, the objective function which households are assumed to wish to maximize is the utility obtain from the set of goals and services consumed. Utility means the usefulness or fulfillment of need which a consumer gains from consuming a good, though for many goods and services, utility can be more simply defined as the pleasure or satisfaction obtained from consumption”.

(Ray Powell, “Economics For Professional and Business Studies”, 2nd edition, DP Publications Ltd, 1993, pp. 26).

        This means that the theory of utility is about the worthiness of a good or service and about those individuals (consumers) that attempt to maximize the total utility provided by goods and services that they acquire and consume.

        The utility of a product can be divided in measurable or marginal utility and in non measurable or derived utility. Since we’re interested in the marginal utility will analyzed it shortly.

Total and marginal utility

It is known that when the price of a product raises the quantity of demand is falling and the opposite. There are exceptions from this rule that are most effected by profitable reasons. We are interested in this, because we’ll base on this rule to explain the negative relationship between price of a product and its demand. This can be explained with the theory of marginal utility.

(Nikolaos G. Marmatakis, “Theoritiki Oikonomiki”, Thessaloniki, 1983).

        As we mentioned before, the ability of products to satisfy needs is called utility. This utility although is not independent from the products. Utility exists when there is a need of satisfaction and a need of obtaining the product. When there is no utility of the product there is no need of acquiring it.

This means that utility varies when the desire of acquiring the product varies.

Also each consumer is different from another and has his own preferences and this means that each consumer has his own way of evaluation of products and his own way of being satisfied from the products and obtaining the utility that provide.

(E. Douglas,” Managerial economics, Theory, Practice and problems”, Prentice hall, 1983).

On the other hand, this utility that products provide is continually falling, and the quantity of a product is also reducing. For example, let us see the utility that a consumer obtains from the consumption of potatoes.

Table 1

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This table shows that when a consumer consumes 1 g of potato in a week it obtains 9 utils. At 5 g obtains 35 etc. The total utility that a consumer obtains results from the quantity that he consumes. The third column is about the marginal utility. The marginal utility law states that as the individual increases the consumption of a given product, as is shown in the table, the marginal utility gained from consumption eventually declines.  

(Roger A. Arnold, “Economics”, 5th edition, 2000)

Graphic description of total and marginal utility

Table2: total utility

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