Hello everyone, in the previous topic we were talking about Law of Demand, Demand Schedule, and Demand Curve. Today we are going to talk about Utility, Cardinal Utility, Ordinal Utility, The Indifference Curve, and Elasticity of Demand.

What is Utility?

The utility is a term in economics matters that refers to the total satisfaction received from consuming a good or service. Economic theories based on judicious decisions usually assume that buyers will endeavor to maximize their utility.

The economic utility of a good or service is essential to comprehend because it is directly impacting the demand, and subsequently cost, of that good or service. Practically speaking, a customer’s utility is difficult to measure and evaluate. However, a few economics experts accept that they can indirectly estimate what is the utility for an economic good or service by utilizing different models.

The utility definition as per economical aspects is the idea of usefulness. An economic good yields utility to the extent to which it’s helpful for satisfying a consumer’s needs and wants. Different ways of thinking vary concerning how to display economic utility and measure the value of a good or service.

What is Cardinal Utility?

Cardinal utility is the utility wherein the satisfaction derived by the consumers from the consumption of a good or service and can be measured numerically.

Cardinal utility measures the utility objectively; Cardinal utility is less realistic, as quantitative measurement of utility is not possible. Cardinal utility is based on marginal utility analysis. The cardinal is measured in terms of units, i.e. units of utility. The Cardinal utility approach was propounded by Alfred Marshall.

Cardinal Utility is the possibility of economic welfare and can be directly observable and be given a value.

For instance, individuals may be able to express the utility that consumption gives for specific products. For instance, A Nissan vehicle gives 5,000 units of utility, and a BMW vehicle would give 8,000 units. This is significant for the welfare of economics which attempts to put values on utilization. For instance, allocative productivity is said to happen when Marginal cost = Marginal Utility.

One method for trying and putting values on goods utility is to see what price they will pay for a commodity.

If we will pay $5,000 for a second-hand Nissan Car, we can infer we should get 5,000 units. As such, the value of cardinal utility is identified with the price we will pay.

The idea of cardinal utility is important to a reasonable decision. The thought consumers make an ideal decision to maximize their utility.

What is Ordinal Utility?

In ordinal utility, the buyer just ranks choices in terms of preference yet we don’t give exact numerical figures for utility.

For instance, we prefer an Audi car to a Honda car, yet we don’t say by how much.

It is argued this is more relevant in reality. When choosing where to go for lunch, we may simply decide I prefer an Italian café to Chinese. We don’t work out on the exact levels of utility.

Carl Menger, an Austrian economist, developed concepts of utility that lay on ranked preferences.

In 1906 Vilfredo Pareto focused on an indifference curve map. This set preferences on bundles of products yet didn’t attempt to say how a lot.

John Hicks and Roy Allen in 1934 first produced a paper that mentioned ordinal utility. 

Indifference Curve

Individuals can’t actually put a numerical value on their level of satisfaction. In any case, they can, and do, identify what choices would give them more, or less, or a similar amount of satisfaction. An indifference curve shows all combinations of commodities that give an equivalent level of utility or satisfaction.

For instance, graph 1, presents 3 indifference curves that address Lilly’s preferences for the tradeoffs that she faces in her two fundamental activities: eating doughnuts and perusing softcover books. Every indifference curve (Ul, Um, and Uh) represents one level of utility. First, we will find the importance of an individual indifference curve, and then we will check out the relationship between different indifference curves.

Graph 1. Lilly’s Indifference Curves. Lilly would get equivalent utility from all combinations of books and doughnuts on a given indifference curve. Any points focus on the highest indifference curve Uh, similar to F, provide greater utility than any focus points like A, B, C, and D on the center indifference curve Um. similarly, any points focus on the middle indifference curve Um provide greater utility than any points on the lowest indifference curve Ul.

The indifference curve is known as the bedrock of modern-day microeconomics. It is a tool that helps us to compare and decide from among gazillion choices available in the world. Classical economists predicted that if we like a certain good or service we tended to receive a fixed amount of utility by consuming it.

For non-Economics folks, utility is an abstract phenomenon. A closer and more relatable semblance of utility is pleasure, quantifiable pleasure actually. With a sweeping wave of mathematization in Economics towards the early years of the last century, a need was felt to help outline how humans made decisions to acquire or let go of goods or services surrounding us. This is a profound question to answer and the world will always be grateful to Wilfred Pareto and Francis Edgeworth for making a successful attempt which is the Indifference Curve.

Indifference curves graphically manifest one’s utility or pleasure between a given set of goods or services. Such an indifference curve has certain less than straightforward traits, to begin with. Indifference curves are monotonic in nature.

In other words, we can say that Indefinite Curve is an alternative combination of two goods that gives the same level of satisfaction.

Some points about Indifference Curve

• An indifference curve is given by Hicks and Allen.
• It is an ordinal approach. (Ordinal means utility cannot be measured in utility, it is not quantifiable).
• It is a combination of two goods.
• It gives the same level of satisfaction.
• Higher Indifferences of curve higher level of satisfaction.
• An indifference curve is also known as the Iso-utility curve.

Properties of Indifference Curve

The properties of the indifference curve are given below-

• The indifference curve slopes downward to the right. If the amount of one good is increased, the number of other goodwill decreases which leads to a downward-sloping curve.
• The indifference curve is always convex to the origin. It is due to the Marginal rate of substitution.
• The indifference curve cannot intersect each other. The higher indifference curve gives a higher level of satisfaction than the lower Indifference Curve It is because of combination lying on a higher Indifference Curve contains more of either one or both goods and more goods are preferred to less of them.
• The indifference curve will never touch either axis. This is born out of the assumption that the consumer prefers a different combination of two goods. If it touches the y-axis point then they prefer units of Y good and zero units of good X. This assumption does not match with the given assumption of the IC. So this will not be applied, hence it will never touch either axis.

Elasticity of Demand

What is Elasticity of Demand?

The elasticity of demand, or demand elasticity, refers to how sensitive demand for a good is compared to changes in other economic factors, like cost or income. It is usually referred to as price elasticity of demand because the price of a good or service is the most common economic factor used to measure it.

Or, the elasticity of demand refers to the degree of responsiveness of the quantity demanded of a commodity to the change in any of its determinants.

Or, the elasticity of demand assists organizations with anticipating changes in demand based on various variables, including changes in cost and the market entry of competitive goods.

An elastic good is defined as one where an adjustment in price leads to a huge change in demand. As a rule, the more substitutes there are for a product, the more elastic demand for it will be.

The elasticity of demand for given goods or services is determined by dividing the percentage change in quantity demanded by the percentage change in cost. If the elasticity quotient is greater than or equivalent to one, the demand is viewed as versatile. While the cost of goods or services is the most widely recognized economic factor used to measure the elasticity of demand, there are different proportions of the elasticity of demand, including income elasticity of demand and substitute elasticity of demand.

Demand is in some cases plotted on a graph: An demand curve shows how the quantity demanded reacts to price changes. The compliment the curve, the more elastic demand is.

These determinants are the price of that commodity, the price of related goods, and income of the consumers, etc. there are mainly three types of elasticity of demand. They are-

• Price elasticity of demand
• Income elasticity of demand
• Substitute elasticity of demand

Price Elasticity of Demand

The elasticity of demand is usually referred to as price elasticity of demand because the cost of goods or services is the most well-known economic factor used to measure it.

For instance, an adjustment of the cost of a smartphone can cause a change in the quantity demanded. If the smartphone producer has an excess of smartphones, they might reduce their cost by trying to expand demand. The extend of the price change will decide whether or not the demand changes and assuming this case, by how much.

Price elasticity of demand is determined by taking the proportional change in the amount purchased (in response to a small change in cost), divided by the corresponding difference in price.

The Uses of Price Elasticity of Demand

Wage Bargaining

The capacity of trade unions to raise wages depends on the elasticity of demand for the product in which labor is used as a major input. If wages are permitted to raise costs; the prices will also rise.

A portion of the cost or even the whole of it may be passed of the cost or even the whole of it may be passed on to the consumer if the demand for the product is inelastic.

If demand is inelastic. If demand is inelastic sales will not fall much due to price rise.

Thus a wage rise is economically feasible in the food industry than in the automobile sector.

Bumper Crops

We know that the demand for most agricultural commodities is highly inelastic. As a result, an increase in the output of wheat or jute due to good harvest or productivity rise due to technological progress may lead to a sharp fall in their prices.

This will lead to a fall in the revenue of the farmers. To help the farmers the government will have to impose restrictions on agriculture out.

Automation

The effect of the use of machinery or employment largely depends on the elasticity of demand for the commodity produced by the firm under consideration.

Suppose a firm introduces a labor-saving machine. This may make 1000 workers unemployed. However, a part of the cost reduction due to the impact of automation i.e., rapid technological advances are passed on to the consumers in the form of the lower price of the product. If the demand for the product is elastic, a small price cut will lead to a more than proportionate increase in demand. As a result, the output may increase to such an extent that 1000 unemployed workers or even more are reabsorbed by the firm.

If demand is inelastic, few, if any, workers can be reemployed, because the volume of the firm’s business will be small.

Airline Deregulation

In the USA there was the regulation of airlines in the 1970s. The basic object was to increase the profits of many carriers. The reason was simple. It was felt that deregulation increased competition among the airlines, thereby lowering airfares. Since the demand for air travel is elastic, lower fares will surely increase total revenue.

When airlines are flying with many empty seats the additional costs of carrying extra passengers is very little. So revenue increases faster than costs and profits rise. A simple example may make the point clear.

Pricing Policy

One can show that the concept of price elasticity has great practical relevance for business pricing policy. When a firm considers changing the prices of its product, it has to take into account the effect of the proposed price change on consumer spending. For example, a reduced selling price may result in lower total revenue because demand is inelastic.

Income Elasticity of Demand

The income elasticity of demand is also called the income effect. The income level of a given population can impact the demand elasticity of products and services.

For instance, assume that an economic event leads to many workers being laid off. During this time frame, individuals may decide to save their money rather than upgrading their cell phones or purchasing designer handbags. This would lead to luxury items turning out to be more elastic. In other words, a slight change in Income level would lead to a critical change in the utilization of luxury goods.

Substitute Elasticity of Demand

Assuming there is any substitute for a good or service, the substitute makes the demand for the good more elastic. The presence of an alternative good or service makes the first good or service more sensitive overall to price changes.

For instance, in case the cost of Android phones increases by 10%, this could make buyers demand less Android phones. Subsequently, an expansion in demand for iPhones leads to more demand for iPhones. Since iPhone smartphones are a close substitute in quality and price, buyer demand for them will rise.

The elasticity of demand generally tells us about the extent to which the amount purchased will respond or change according to a change in its determinants.

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