CHAPTER-2 LAWS OF UTILITY

LAWS OF DIMINISHING MARGINAL UTILITY (DMU):Dr. Marshall states this, law as follow: The additional benefit which a person derives from a given increase of his stock of anything diminishes with the growth of the stock that he has another words the law of DMU simply states that other things being equal, the marginal utility derived from successive units of a given commodity goes on decreasing. Hence the more we have of a thing; the less we want of it, because every successive unit gives less and less satisfaction. The law is explained with the help of following example Total Utility (TU) Marginal Utility Units of commodity No. Of (MU) mangoes 1 3 8 2 14 6 3 16 2 4 16 0 5 14 (-) 2

It will be better to know some terms for understanding the law and they are. 1. Initial Utility: It is the utility of the initial or the first unit. In the table initial utility is 8 2. Total Utility: In column 3 of the table, it gives the total utility at each step. For example it you consume on mango are total utility is 3, if you consume two mangoes, the total utility is 14. 3. Zero Utility: When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of zero utility. In our table, the TU after the 3rd unit is consumed is 16 and ar the 4th also it is 16. Thus, the 4th mango results in no increase. Thus is the point of zero utility. It is seen that the total utility is maximum when the MU is zero. 4. Marginal Utility: The addition to the total utility by the consumption of the last unit considered just worthwhile. The can be worked out by using following formula. 5. Negative Utility: It the consumption of a unit of a commodity is carried to excess, then instead of giving any satisfaction, it may cause dissatisfaction. The utility in such cases is negative. In the table given above the marginal utility of the 5th unit is negative. Assumptions: The assumptions of the law of DMU are: 1. All the units of the given commodity are homogenous i.e. identical in size shape, quality, quantity etc. 2. The units of consumption are of reasonable size. The consumption is normal. 3. The consumption is continuous. There is no unduly long time interval between the consumption of the successive units. 4. The law assumes that only one type of commodity is used for consumption at a time. 5. Though it is psychological concept, the law assumes that the utility can be measured cardinally i.e. it can be expressed numerically. 6. The consumer is rational human being and he aims at maximum of satisfaction. Exceptions: The exceptions to the law of DMU are as follows:

1. Hobbies: In case of certain hobbies like stamp collection or old coins, every addition unit gives more pleasure. MU goes on increasing with the acquisition of every unit. 2. Drunkards: It is belives that every does of liquor Increases the utility of a drunkard. 3. Miser: In the case of miser, greed increases with the acquisition of every additional unit of money. 4. Reading: reading of more books gives more knowledge and in turn greater satisfactions. Importance of the law of DMU: 1. Basic of economic law and concepts: This law of DMU forms the basis of law of demand, law of Equimarginal utility, elasticity of demand etc. 2. Public finance: The Govt. can impose and justify progressive income tax on the ground of this law, as the income increases, the MU of income diminishes. 3. Businessmen: A businessman or producer can increase the sale of his product by fixing a lower price. Since consumers tend to buy more to equate MU with price, a producer can expect a rise in sale.

Utility Analysis: Law of Diminishing marginal Utility (DMU) Dr. Marshall states this, law as follow: The additional benefit which a person derives from a given increase of his stock of anything diminishes with the growth of the stock that he has another words the law of DMU simply states that other things being equal, the marginal utility derived from successive units of a given commodity goes on decreasing. Hence the more we have of a thing; the less we want of it, because every successive unit gives less and less satisfaction. The law is explained with the help of following example Total Utility (TU) Marginal Utility (MU) 3 14 16 16 14 8 6 2 0 (-) 2

Units of commodity No. Of mangoes 1 2 3 4 5

It will be better to know some terms for understanding the law and they are.

1. Initial Utility: It is the utility of the initial or the first unit. In the table initial utility is 8 2. Total Utility: In column 3 of the table, it gives the total utility at each step. For example it you consume on mango are total utility is 3, if you consume two mangoes, the total utility is 14. 3. Zero Utility: When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of zero utility. In our table, the TU after the 3rd unit is consumed is 16 and ar the 4th also it is 16. Thus, the 4th mango results in no increase. Thus is the point of zero utility. It is seen that the total utility is maximum when the MU is zero. 4. Marginal Utility: The addition to the total utility by the consumption of the last unit considered just worthwhile. The can be worked out by using following formula. 5. Negative Utility: It the consumption of a unit of a commodity is carried to excess, then instead of giving any satisfaction, it may cause dissatisfaction. The utility in such cases is negative. In the table given above the marginal utility of the 5th unit is negative. Assumptions: The assumptions of the law of DMU are: 1. All the units of the given commodity are homogenous i.e. identical in size shape, quality, quantity etc. 2. The units of consumption are of reasonable size. The consumption is normal. 3. The consumption is continuous. There is no unduly long time interval between the consumption of the successive units. 4. The law assumes that only one type of commodity is used for consumption at a time. 5. Though it is psychological concept, the law assumes that the utility can be measured cardinally i.e. it can be expressed numerically. 6. The consumer is rational human being and he aims at maximum of satisfaction. Exceptions: The exceptions to the law of DMU are as follows: 1. Hobbies: In case of certain hobbies like stamp collection or old coins, every addition unit gives more pleasure. MU goes on increasing with the acquisition of every unit. 2. Drunkards: It is belives that every does of liquor Increases the utility of a drunkard. 3. Miser: In the case of miser, greed increases with the acquisition of every additional unit of money. 4. Reading: reading of more books gives more knowledge and in turn greater satisfactions. Importance of the law of DMU:

1. Basic of economic law and concepts: This law of DMU forms the basis of law of demand, law of Equimarginal utility, elasticity of demand etc. 2. Public finance: The Govt. can impose and justify progressive income tax on the ground of this law, as the income increases, the MU of income diminishes. 3. Businessmen: A businessman or producer can increase the sale of his product by fixing a lower price. Since consumers tend to buy more to equate MU with price, a producer can expect a rise in sale. LAW OF EQUIMARGINAL UTILITY (EMU) This law of Equimarginal Utility is another fundamental principle of Economics. It is also known as law of substitution or law of Maximum satisfaction. We have already seen that human wants are unlimited whereas the means to satisfy these wants are strictly limited. It therefore becomes necessary to pick up the most urgent wants that can be satisfied with the money that a consumer has. In order to get maximum satisfaction out of the funds (money) we have, we carefully weigh the satisfaction obtained from each rupee that we spend. If we find that a rupee spend in one direction has greater utility than in another, we shall go non spending money, on the former ( first) commodity, till the satisfaction derived from the last rupee spent in the two cases is equal. In other words, we substitute some units of commodity of greater utility for some units of the commodity of less utility. The results of this substitution will be the MU of the former will fall and that of the latter will rise, till the two marginal utilities are equalized. That is why this law is called the laws of substitution or equimarginal utility. This law has been illustrated with the help of table given below. Marginal oranges 10 8 6 4 2 0 2 4 Utility ofMarginal apples. 8 6 4 2 0 2 4 6 Utility of

Units 1 2 3 4 5 6 7 8

Suppose apples and oranges are the commodities to be purchased suppose we have go seven rupees to spend. Let us spend three rupees on oranges and four rupees on apples. The utility of 3rd unit of oranges is 6 and that of the 4th unit of apples is 2. As the MU of oranges is higher, we should buy more of oranges and less of apples. Let us substitute one orange for one apple so that we buy four oranges and three apples. Now the MU of both oranges and apples is the same i.e. 4. This arrangement yields maximum satisfaction. Thus total utility of 4 oranges would be 10+8+6+4=23 and of three apples 8+6+4=18 which

gives a total utility of 46. The satisfaction given by 4 oranges and 3 apples of on one rupee each is grater than could be obtained by any other the total utility fiends less than 46. Thus, it can be concluded that we obtain maximum satisfaction when we equalize marginal utilities by substituting some unit of the more useful for the less useful commodity. Limitation of the Law of Equi- Marginal Utility: 1. Ignorance: If a consumer is ignorant and blindly follows custom, he will may not make wrong use of money. 2. Inefficient organizer: The inefficient business organizer will final to achieve the best result from the land, labour and capital. That he employs. 3. Unlimited resources: When the resources are sample this law will be meaning less. 4. Hold of custom and fashion: It the purchase is strongly influence by customer and fashion he will not obtain maximum satisfaction. 5. Frequent changes in prices of different goods and services are occurred the observance of this law is difficult. Practical Importance of Law of EMU: 1. Consumption: A wise consumer acts on this law while arranging his expenditure and obtains maximum satisfaction. 2. Production: To obtain maximum net profit, he must substitute one factor of producing to another so as to have most economical combination. 3. Exchange: Exchange implies substitution of one thing to another and hence this law is important. 4. Distribution: It is on the principle of the marginal productivity that the share of each factor of production is determined. 5. Public finance: The Govt. is also guided by this law in public expenditure. The Govt. can expend its revenue (money) in such a way that it will secure maximum welfare of the people. CONSUMERS SURPLUS Consumers surplus is one of the most important concepts in Economics. It was expounded by Alfred Marshall. We often find that the price we pay for a commodity is usually less than the satisfaction we derived from its consumption for example, when we purchase a packet of salt, match-box, news paper etc. and consume, the satisfaction derived from those is greater as compared to the price paid for them. This what consumer surplus mean. The concepts can be defined as under. 1. Consumers surplus is the excess of what we are prepared to pay over what we actually pay for a commodity. 2. It is difference between what we are prepared to pay and what we actually pay. 3. Consumers surplus: Total Utility - Total Amount spend

Explanation: We can illustrate the concept of consumers surplus with the help of the table given below. Marginal Utility Price (Rs.) 2 2 2 2 2 10 surplus = = Total 30 Consumers Surplus 8 6 4 2 0 20 Utility total 10 amount i.e. spent 20.s

Unit (Orange) 1 10 2 8 3 6 4 4 5 2 Total 30 Hence

consumers

It is assumed in the above table the price of oranges in the market is Rs. 2.00 per orange. A consume will purchase as may oranges as make his, marginal utility equal to the price. Thus he will purchase 5 orange and pay for each Rs. 2.00. In this way he will spend Rs. 10.00 But the total utility of the 5 oranges is equal to Rs. 30.00. He thus gets a consumers surplus equal to (30-10) Rs. 20.00 The consumers surplus can also be found from fourth column of the table. The utility of the first unit of oranges to the consumer is equal to Rs. 10.00, therefore be would be prepared to pay Rs. 10.00 for its rather than go with out is. But be pays for the first orange only Rs. 2.00, because the price of an orange in the market is Rs. 2.00. Therefore, from the first unit, the consumer is surplus equal to (10-2) = Rs. 8.00, which is written in the fourth column. Similarly the utility of second orange is equal to 8 while the consumer pays Rs. 2.00 for its and therefore obtains (8-2) = Rs. 6.00 as consumers surplus. From 5th orange the consumer derives satisfaction equal to Rs. 2.00 and as such the consumers surplus from fifth unit is equal to (2-2) = 0. Thus if we calculate the total utility obtained (i.e. 30) and total amount paid (Rs. 10.00), the consumers surplus as given in column no four is equal to. Rs. 20.00 Practically however the measurement of consumers surplus is not simple. There are numerous difficulties to measure consumers surplus exactly in the market but it is possible to have rough estimate which is of very great practical value. CRITICISM: The concept of consumers surplus has been critised on several grounds. 1. It is said that this concept is imaginary idea. It is very difficult to say how much one is prepared to pay and if it is said it will unreal.

2. It is very difficult to measure exactly. Because different people are prepared to pay different amount (price) and hence it is very difficult to measure total consumers surplus in the market. 3. This concept does not apply to necessaries. For example, if we ask how much a man be prepared to pay for a glass of water when he is dying of thirst, it is very difficult to say an exact amount. Thus, consumers surplus in such cases is immeasurable. Importance of consumers surplus: This concept is useful in a number of ways. In public finance: It is very useful to Finance Minister in imposing taxes and fixing the rates. He will impose more taxes on commodities in which consumers surplus is more.

To the businessman and monopolistic as they can increase the price of the commodities in which there is large consumers surplus. Comparing advantages of different places. Measuring Benefits from international trad

Utility Analysis: Law of Diminishing marginal Utility (DMU) Dr. Marshall states this, law as follow: The additional benefit which a person derives from a given increase of his stock of anything diminishes with the growth of the stock that he has another words the law of DMU simply states that other things being equal, the marginal utility derived from successive units of a given commodity goes on decreasing. Hence the more we have of a thing; the less we want of it, because every successive unit gives less and less satisfaction. The law is explained with the help of following example Total Utility (TU) Marginal Units of commodity No. Of (MU) mangoes 1 3 8 2 14 6 3 16 2 4 16 0 5 14 (-) 2 Utility

It will be better to know some terms for understanding the law and they are.

1. Initial Utility: It is the utility of the initial or the first unit. In the table initial utility is 8 2. Total Utility: In column 3 of the table, it gives the total utility at each step. For example it you consume on mango are total utility is 3, if you consume two mangoes, the total utility is 14. 3. Zero Utility: When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of zero utility. In our table, the TU after the 3rd unit is consumed is 16 and ar the 4th also it is 16. Thus, the 4th mango results in no increase. Thus is the point of zero utility. It is seen that the total utility is maximum when the MU is zero. 4. Marginal Utility: The addition to the total utility by the consumption of the last unit considered just worthwhile. The can be worked out by using following formula. 5. Negative Utility: It the consumption of a unit of a commodity is carried to excess, then instead of giving any satisfaction, it may cause dissatisfaction. The utility in such cases is negative. In the table given above the marginal utility of the 5th unit is negative. Assumptions: The assumptions of the law of DMU are: 1. All the units of the given commodity are homogenous i.e. identical in size shape, quality, quantity etc. 2. The units of consumption are of reasonable size. The consumption is normal. 3. The consumption is continuous. There is no unduly long time interval between the consumption of the successive units. 4. The law assumes that only one type of commodity is used for consumption at a time. 5. Though it is psychological concept, the law assumes that the utility can be measured cardinally i.e. it can be expressed numerically. 6. The consumer is rational human being and he aims at maximum of satisfaction. Exceptions: The exceptions to the law of DMU are as follows: 1. Hobbies: In case of certain hobbies like stamp collection or old coins, every addition unit gives more pleasure. MU goes on increasing with the acquisition of every unit. 2. Drunkards: It is belives that every does of liquor Increases the utility of a drunkard. 3. Miser: In the case of miser, greed increases with the acquisition of every additional unit of money. 4. Reading: reading of more books gives more knowledge and in turn greater satisfactions. Importance of the law of DMU:

1. Basic of economic law and concepts: This law of DMU forms the basis of law of demand, law of Equimarginal utility, elasticity of demand etc. 2. Public finance: The Govt. can impose and justify progressive income tax on the ground of this law, as the income increases, the MU of income diminishes. 3. Businessmen: A businessman or producer can increase the sale of his product by fixing a lower price. Since consumers tend to buy more to equate MU with price, a producer can expect a rise in sale.

CHAPTER 3

Demand is the willingness and ability to purchase a particular good or service The demand curve specifies a range of quantities (or amounts) of a good or service that a person or business is willing to purchase at each particular price. For example, if the price of coffee is $2.00 a cup, you would be willing to buy 3 cups a week. If the price of coffee is $.50 a cup, you would be willing to buy 10 cups a week. At every price a consumer is willing to purchase some quantity of a good or service. The demand curve has a negative slope because it embodies the law of demand. Notice, when the price goes up the consumer is willing to buy less of the good.

DETERMINANTS OF DEMAND Demand for a commodity is influenced by many factors. These factors are known as determinants of demand, because they determine the quantity demanded of a commodity. It is also known as demand function. The amin determinants of demand are as follows: (1) Price(Px): Basically the amount of a commodity demanded per unit of time depends upon the price charged for it. Usually higher the price, the lower will be the quantity demanded and vice versa. (2) Income(Y): The households demand for a commodity is influenced by the size of its income. In most cases, larger the income, the greater will be the quantity demanded. At, present, the demand for goods does not contract in India inspte of price rise, because money incomes are increasing rapidly, and the effect of income is more powerful than that of price rise. (3) Taste and Preference(T): Tastes and preferences of the people can have a powerful influence on the level of demand for a commodity. If a particular commodity comes into fashion, it will be demanded in large quantity even if its

(4)

(5)

(6)

(7)

price is high. Conversely, if a commodity goes out of fashion, its demand will decline in spite of fall in price. Prices of Related Commodities(PyPx): Demand fro a commodity X is influenced by the level of price of some other related commodity y or so. Take the example of substitute goods. Tea and coffee are substitute goods. If price of tea falls, some people will substitute tea fro coffee. Thus demand for coffee declines though its price is constant. Now take an example of complementary goods. The fountain pen and ink are complementary goods. If price of fountain pen falls, more fountain pen will be bought. Size of the Population(D): Total demand for a commodity depends upon the number of its consumers. The larger the number of consumers, the larger will be the demand for that commodity. The number of consumers for a commodity depends upon the size of population- a demographic factor. For instance, the number of consumers of wheat will increase with the growth of population in the country. Hence demand for wheat will increase. Expectations about Future Price (E): Demand for a commodity will depend on peoples expectation about its future price also. Demand for wheat will increase in price. Conversely, deamand for wheat will decrease inspite of its low price at present, if people expect a rather fall in price. Income Distribution(Y) The pattern of demand for goods depends on the pattern of income distribution. If there is an increase in income inequality due to the transfer of incomes from the poor to the rich, the pattern of demand will change in favour of luxuries. If income inequlity is reduced, and the purchasing power shifts fro the rich