A.8] Utility Principles and Opportunity Cost

A.8.1] Utility Principles

Definition

• Utility refers to the satisfaction or benefit derived from consuming a good or service.
• It is a central concept in microeconomics and consumer theory.

Key Principles

• Total Utility (TU): The total satisfaction received from consuming a given quantity of a good.

  • Example: Eating 3 apples may give a total utility of 20 units.

• Marginal Utility (MU): The additional satisfaction gained from consuming one more unit of a good.

  • Formula: $ MU = TU_n - TU_{n-1} $
  • Example: The 4th apple may give an additional 5 units of utility.

• Law of Diminishing Marginal Utility: As more units of a good are consumed, the marginal utility derived from each additional unit decreases.

  • Important Date: The concept was formalized by Herbert Spencer in the 19th century.
  • Example: Eating more chocolates may eventually lead to a decrease in satisfaction.

• Cardinal Utility Approach: Assumes utility can be measured in numerical terms.

  • Proponents: Alfred Marshall, Francis Ysidro Edgeworth.

• Ordinal Utility Approach: Assumes utility can only be ranked, not measured numerically.

  • Proponents: Vilfredo Pareto, Paul Samuelson.

Exam-Focused Facts

• SSC/RB Questions Often Focus On:
  • Law of diminishing marginal utility
  • Difference between total and marginal utility
  • Cardinal vs. ordinal utility

Table: Comparison of Utility Concepts

A.8.2] Opportunity Cost

Definition

• Opportunity Cost is the value of the next best alternative that is foregone when a choice is made.
• It is a fundamental concept in microeconomics and resource allocation.

Key Concepts

• Explicit Cost: Direct out-of-pocket expenses.

• Implicit Cost: Opportunity cost of using owned resources.

• Total Cost = Explicit Cost + Implicit Cost

• Opportunity Cost Principle: Every decision involves a trade-off.

  • Example: Choosing to study for an exam instead of working a part-time job.

Application in Economics

• Production Possibility Frontier (PPF): Illustrates opportunity cost between two goods.

  • Example: Producing more consumer goods means producing less capital goods.

• Sunk Cost Fallacy: Decisions should not be based on past costs.

  • Example: Continuing to invest in a failing business due to prior investments.

Exam-Focused Facts

• SSC/RB Questions Often Focus On:
  • Definition and examples of opportunity cost
  • Difference between explicit and implicit costs
  • Application in production possibility frontier

Table: Opportunity Cost vs. Explicit Cost

Key Terms

• Opportunity Cost – The value of the next best alternative.
• Sunk Cost – A cost that has already been incurred and cannot be recovered.
• Production Possibility Frontier (PPF) – A curve showing the maximum possible output combinations of two goods.

Important Dates

• 1930s: The concept of opportunity cost was popularized by John Maynard Keynes and Paul Samuelson.
• 1950s: The PPF was widely used in economic planning and resource allocation models.

Summary

• Utility principles help in understanding consumer behavior and decision-making.
• Opportunity cost is essential for evaluating trade-offs and resource allocation.
• Both concepts are frequently tested in SSC and RRB exams, especially in economics and general awareness sections.