Lecture 3. Wants, goods and utility

1. Wants. Classification of wants.

2. Goods. Classification of goods.

3. Utility. The magnitude of utility. Total, average and marginal utility.

4. The law of diminishing marginal utility.

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The main reason of wants variety is diversity of human nature. As usual, variety of wants determined by physical, social, economic, psychological particularities of a person.

Want (need) – is state of satisfaction which person tries to maintain or state of dissatisfaction which person tries to finish. Want (need) – is necessity in particular good or service.

Wants are high changeable and have a tendency to increase. There are several causes of its classification.

1. Primary and secondary.

Primary – the main want for living – needs to eat, to drink, to sleep, to wear and so on. These wants can’t be substituted.

Secondary – needs in luxury things, jewelry, expensive cars, buildings and so on. These wants can be substituted.

2. Individual and collective.

Individual – are wants which are satisfied privately, for example washing.

Collective - are wants which are satisfied only in group of people, for example collective games, watching film in cinema, attending theatre and so on.

3. Economic and uneconomic.

Economic – are wants in limited goods – any commodity.

Uneconomic – are wants in unlimited goods, for example fresh air, salt water, wind and so on.

4. Material, social, spiritual.

Material – needs in clothing, eating, drinking, home and so on.

Social – needs in conversation, labour, social life participation and so on.

Spiritual - needs in education, culture, spiritual freedom and so on.

Variety of wants forms particular hierarchy, which received a name “Maslow pyramid” (1954). It consists from 5 levels. On the 1^st level physical needs are placed. On the 2^nd – needs in security. On the 3^rd – needs in love and friendship. On the 4^th – needs in appreciation and respect. On the 5^th – needs in self-realization.

The first 2 levels characterize person from economic side, the last 3 levels characterize person from social side.

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Good – is a thing that satisfies particular human need.

According to needs classification there is classification of goods.

1. Primary and secondary.

Primary – are used to satisfy primary wants: food, drinks, rest, home and so on.

Secondary – are used to satisfy secondary wants: luxury things, jewelry, expensive cars, buildings and so on.

2. Individual and collective.

Individual – are elements of self hygiene.

Collective – are collective games, cinema, theatre and so on.

3. Economic and uneconomic.

Economic – are limited goods: any commodity.

Uneconomic – are unlimited goods: fresh airs, salt water, wind and so on.

4. Material, social and spiritual.

Material – satisfy material wants: clothing, food, drinks, home and so on.

Social – satisfy social wants: conversation, labour, social life participation and so on.

Spiritual – satisfy spiritual wants: education, culture, spiritual freedom and so on.

5. Substitutes, complements, independent goods, goods with negative utility.

Substitutes – are alternative goods which satisfy the same want but aren’t used together, for example: tea and coffee, juice and mineral water.

Complements – are goods which together satisfy the same need and aren’t used without each other, for example automobile and petrol, printer and cartridge.

Independent goods – are goods which are not substitutes or complements from consumer point of view, for example ice-cream and pen.

Goods with negative utility – are goods with we have to delete, for example rubbish.

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Utility is the capacity of a good (or service) to satisfy a want. It is one approach which explains the phenomenon of value. Utilitarianism is the ethical foundation of neoclassical microeconomics. Jeremy Bentham [1748-1832] formalized “utilitarianism.” Utility is a subject evaluation of value.

Heinrich Gossen [1810-1858] developed the “law of satiable wants” which is considered to be a precursor of the “law of diminishing marginal utility. In 1871 William Stanley Jevons [1835-1882] used the term “final degree of utility” and Carl Menger [1840-1921] recognized that individuals rank order their preferences. It was Friedrich von Wieser, [1851-1926] who first used the term “marginal utility.”

Since utility is subjective and cannot be observed and measured directly, special unit – utile is used to measure it. Utility can be total, marginal and average.

Total utility (TU_x) is defined as the amount of satisfaction or utility that one derives from a given quantity of a good.

Total Utility = TU_x = f (Q_x, preferences, )

As a larger quantity of a good is consumed in a given period we expect that the TU will increase at a decreasing rate. It may eventually reach a maximum and then decline. Imagine that you went to pizzeria and ate too much pizza. Each new pizza gave you less utility than previous one. 10 units of utility are obtained by consuming 1pizza. The consumption of 2 pizzas results in a total of 18 units of satisfaction. The maximum satisfaction that can be derived from the consumption of pizza is 27. This occurs at 5 pizzas. If the individual eats more than 5 pizzas their total satisfaction declines. Total Utility can be displayed in graph.

U_x

C

TU_x

0 S Q_x

Marginal utility (MU_x) is defined as the change in total utility that can be attributed to a change in the quantity consumed. MU – is utility of one additional unit consumed.

Marginal Utility = MU_x = ΔTU_x/ ΔQ_x

Marginal utility (MU) is the change in TU that is “caused” by a change in the quantity consumed in the particular period of time.

Marginal utility is calculated by subtraction. The change in quantity from row to row is 1 (ΔQ = 1). Therefore the change in total utility can be calculated by subtracting the TU associated with each quantity from that associated with the next quantity. The total utility (TU) derived from 1 unit of the good is 10. The TU derived from 2 units is 18; the change in total utility (ΔTU) attributable to a one unit change in quantity (ΔQ) is 8. Total Utility can be displayed in graph.

МU_x

0 1 2 3 S Q_x

Average utility (AU_x) – ratio between amount of total utility and number of units consumed.

Average utility = АU_x = TU_x / Q_x

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Heinrich Gossen [1810-1858] developed the “law of satiable wants” which is considered to be a precursor of the “law of diminishing marginal utility.

The law of diminishing marginal utility states that as an individual consumes more and more of a given commodity during a given period of time, eventually each additional unit consumed will increase TU by a smaller increment and decrease MU. This is called “diminishing marginal utility.”

The correlation between TU and MU can be shown graphically.

During TU increase MU decreases. When TU reaches its maximum – MU is equal zero. When TU decreases MU becomes negative.

As a person consumes larger quantities of a good in a given time period, additional units have less “value.” Adam Smith recognized this phenomenon when he posed this “diamond-water paradox.” Water has more utility than diamonds. However, since water is plentiful, it’s marginal value and hence its price is lower than the price of diamonds that are relatively scarce.

The law of diminishing marginal utility functioning in particular conditions:

1. Tastes and preferences of consumer are unchangeable during set period of time.

2. All units of goods are full substitutes.

3. Goods are consumed one by one.

U_x

C

TU_x

0 S Q_x