The concepts of Utility functions- not withstanding how much misused, mishandled - can be put into effective use to answer the bunch of questions that I ended with in my last blog. Assuming many of the readers to be non-economist I would explain the concept as I go ahead defining the functions of utility in the current context and the budget-constraint line. I will try to make things as lucid as I can.
Meanwhile let me tell you, I am back with my enthusiasm of continuing with my futile task and development of the functions for the other variables, simply because I get the feeling that it is my blog and I have the right to express my opinions. Contentions are always welcome. However now I will take time in posting in order to make sure that there is no misinterpretation.
Let us consider two baskets. Call them B1 and B2. These baskets contain different needs of a human. I am trying to commoditize these needs. The two baskets contain needs that dis balances each other. Although I am not saying the needs are independent.
Let us imagine:
B1 contains Career, Luxury, Money, Ego, Glamor
B2 contains Family, Hobby, Recreation
Let us say there are a number of each of these baskets (equivalent in nature) available in the market. The question I am trying to answer is the number of B1 and B2 a rational individual would buy from the market. For this we define two functions: One is the utility function and the other is the budget constraint. As the name suggests the utility function would mean the utility derived out of a certain combination of B1 and B2. While the budget constraint is the line which constraints your buying based on your total income. You might have started wondering where this income is coming from. Let me explain, for those who have not had a course in economics. If you substitute the contents of B1 with oranges and B2 with apples. Then your utility function is the nutrients that you gain out of the baskets. But you can only buy a maximum of these baskets with your income. Coming back to the current context the utility function is your satisfaction level with the individual baskets. The budget constraint is certainly not income but some other variable which I will explain later.
Defining the Utility Function: For a general understanding please click here.
Figure 1 describes the general nature of the utility function. The Y-axis shows the number of B1 and X-axis the number of B2.
Note:
1) Each curve is an iso-satisfaction line. Which means take any combination of B1 and B2 from a particular line and compare it with another point on the same line, the two would give you same level of satisfaction.
2) Points on different lines would give different amount of satisfaction.
3) In general as you move in a north east direction, the satisfaction levels on the lines keep on increasing.
4) As the number of B1 increases the satisfaction gained out of B1 increases at at a decreasing rate. For example: 13 apples and 14 oranges might give you same level of satisfaction as 12 apples and 15 oranges. Where rate of substitution of apple with orange is 1. But on the same line 3 apples and 30 oranges would give you same level of satisfaction as 2 apples and 40 oranges. The numbers are insignificant. I just wanted to explain the nature of the curves. Why they are flattened at increasing B2 and straightened at increasing B1.
5) As I claimed that as one moves north east the satisfaction level in general increases. This would be due to some exogenous variable. For example if the salary of that person increases. Taking the fruits example oranges somehow become more sweet.
(I am not going to break this post in a series. Since it would take some more time before I finish this blog I thought of publishing this much, so that readers can have a grasp of the matter. I will later on edit the post, and post the rest of the matters as it is prepared.)
2 comments:
I disagree with you on this. You said as we move in the NE direction, satisfaction increases because of an exogenous variable. I'd say the satisfaction increases because the person is consuming more of both B1 and B2.
I don't see the effect of an exogenous variable here.
The exogenous variable you are referring to will be important when we compare people of different income levels, but it'll work in the opposite way. The marginal utility of each apple/orange will decrease as the income increases. This is plainly because he can now afford to buy more apples/oranges and hence the value of each apple/orange decreases.
@ Nattu
No...the utility will increase in the North East direction because there is some exogenous variable which causes an increase in the consumption of both B1 & B2. So the basic reason is change in some exogenous variable and not change in any of the variables present in the baskets.
You are right to say that the marginal utility will decrease with increase in income. But that is the marginal utility of increase in one more apple and not any apple
Any way I am still desperately searching for time to finish this article
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