Faculty of Law, Aligarh Muslim

University

2021

Economics
(Tutorial & Project Work)
On

‘Project Topic-The Concept of cost’

Submitted to;
Dr. Mohd. Rahmatullah

Submitted by;
SHREYANSH CHAUDHARY
Roll.No.- 20 BALLB 054
BA LLB III Semester (Section A)
Enrolment No.- GK 9302
Assignment
for

Tutorial
Test
 Table of Contents
• Introduction

• Ordinal Utility

• Cardinal Utility

• Definition of Total Utility

• Marginal Utility Analysis

• Assumptions of Marginal Utility Analysis

• The Law of Diminishing Marginal Utility

o An Illustration

• Relationship between total and marginal utility

• Conclusion & Bibliography

 Introduction
Utility is a term in economics that refers to the total satisfaction
received from consuming a good or service. Economic theories based
on rational choice usually assume that consumers will strive to
maximize their utility. The economic utility of a good or service is
important to understand, because it directly influences the demand,
and therefore price, of that good or service. In practice, a consumer's
utility is impossible to measure and quantify. However, some
economists believe that they can indirectly estimate what is the utility
for an economic good or service by employing various models.

The utility definition in economics is derived from the concept of

usefulness. An economic good yields utility to the extent to which it's
useful for satisfying a consumer’s want or need. Various schools of
thought differ as to how to model economic utility and measure the
usefulness of a good or service. Utility in economics was first coined
by the noted 18th-century Swiss mathematician Daniel Bernoulli.
Since then, economic theory has progressed, leading to various types
of economic utility.
 Ordinal Utility
Early economists of the Spanish Scholastic tradition of the 1300s and
1400s described the economic value of goods as deriving directly
from this property of usefulness and based their theories of prices and
monetary exchanges. This conception of utility was not quantified, but
a qualitative property of an economic good. Later economists,
particularly those of the Austrian School, developed this idea into an
ordinal theory of utility, or the idea that individuals could order or
rank the usefulness of various discrete units of economic goods.

Austrian economist Carl Menger, in a discovery known as

the marginal revolution, used this type of framework to help him
resolve the diamond-water paradox that had vexed many previous
economists. Because the first available units of any economic good
will be put to the most highly valued uses, and subsequent units go to
lower-valued uses, this ordinal theory of utility is useful for
explaining the law of diminishing marginal utility and fundamental
economic laws of supply and demand.
 Cardinal Utility
To Bernoulli and other economists, utility is modeled as a
quantifiable or cardinal property of the economic goods that a person
consumes. To help with this quantitative measurement of satisfaction,
economists assume a unit known as a “util” to represent the amount
of psychological satisfaction a specific good or service generates for
a subset of people in various situations. The concept of a measurable
util makes it possible to treat economic theory and relationships using
mathematical symbols and calculations.

However, it separates the theory of economic utility from actual

observation and experience, since “utils” cannot actually be
observed, measured, or compared between different economic goods
or between individuals.

If, for example, an individual judges that a piece of pizza will yield 10
utils and that a bowl of pasta will yield 12 utils, that individual will
know that eating the pasta will be more satisfying. For the producers
of pizza and pasta, knowing that the average bowl of pasta will yield
two additional utils will help them price pasta slightly higher than
pizza.
Additionally, utils can decrease as the number of products or services
consumed increases. The first slice of pizza may yield 10 utils, but as
more pizza is consumed, the utils may decrease as people become full.
This process will help consumers understand how to maximize their
utility by allocating their money between multiple types of goods and
services as well as help companies understand how to structure tiered
pricing.

The Definition of Total Utility

If utility in economics is cardinal and measurable, the total utility
(TU) is defined as the sum of the satisfaction that a person can
receive from the consumption of all units of a specific product or
service. Using the example above, if a person can only consume three
slices of pizza and the first slice of pizza consumed yields ten utils, the
second slice of pizza consumed yields eight utils, and the third slice
yields two utils, the total utility of pizza would be twenty utils.
 Marginal Utility Analysis
Marginal Utility analysis helps us understand the behavior of a
consumer by looking at the way he spends his income on different
goods and services to attain maximum satisfaction. In this article, we
will look at the assumptions, laws, and limitations under marginal
utility analysis.

Assumptions of Marginal Utility

Analysis
1] The Cardinal Measurability of Utility

This theory states that utility is a cardinal concept. In other words, it

is measurable and quantifiable. Hence, you can say that you derive a
utility of 10 units from consuming 1 unit of commodity A and 5 from
consuming 1 unit of commodity B. This can help you compare
different commodities and analyze which commodity offers better
utility or satisfaction.

The theory further states that money is the measuring rod of utility.
So, the amount of money that you are willing to spend for a unit of
commodity rather than going without it is the measure of utility that
you derive from the said commodity.

2] The constancy of the Marginal Utility of Money

The second assumption is that when you are spending money on a

commodity, the marginal utility of money remains constant
throughout. This facilitates the measurement of the utility of
commodities in terms of money.

3] The Hypothesis of Independent Utility

This theory ignores the complementarity between goods. It states that

the total utility that you get from a collection of goods is a simple sum
total of the separate utilities of each good.

The Law of Diminishing Marginal

Utility
This is an important law under Marginal Utility Analysis. Alfred
Marshall, British Economist defines the law of diminishing marginal
utility as follows:

“The additional benefit which a person derives from a given increase

in the stock of a thing diminishes with every increase in the stock that
he already has.”
This law is based on the fundamental tendency of human
nature. Human wants are virtually unlimited. However, every single
want is satiable. Hence, as we consume more and more units of a
good, the intensity of our want for the good decreases. Eventually, it
reaches a point where we no longer want it.

In other words, as we consume more units of a good, the extra

satisfaction that we derive from the extra unit keeps falling. However,
it is important to remember that the marginal utility declines NOT the
total utility.

An Illustration

Let us see an example. The table below presents the total and
marginal utility derived by Peter from consuming cups of tea per day.

Quantity of Marginal
Total Utility
Teas Utility

1 30 30

2 50 20

3 65 15

4 75 10
 5 83 8

6 89 6

7 93 4

8 96 3

9 98 2

10 99 0

11 95 -4

As seen in the table above, when Peter consumes one cup of tea in a
day, he derives a total utility of 30 utils (unit of utility) and a marginal
utility of 30 utils. When he takes two cups per day, the total utility
rises to 50 utils but the marginal utility falls to 20. This trend
continues until the last row where the marginal utility is negative.
This means that if Peter consumes 11 or more cups of tea per day,
then he might fall sick. Here is a graph representing the table:
 Relationship between Total and
Marginal utility
1. As the total utility rises, the marginal utility diminishes
2. When the total utility is maximum, the marginal utility is zero.
3. As the total utility starts diminishing, the marginal utility
becomes negative.

This law helps us understand how a consumer reaches equilibrium in

case of a single commodity. Typically, a consumer utilizes a
commodity until its marginal utility becomes equal to the market
price. This ensures that he derives maximum satisfaction by being in
equilibrium in respect of the quantity of the commodity.
In case of a fall in the price of the commodity, the equality between
marginal utility and price gets disturbed. Therefore,
the consumer will consume more units of the good leading to a fall in
the marginal utility. He continues consuming until the equilibrium is
achieved. On the other hand, in case of a rise in the price of the
commodity, he will consume less and achieve equilibrium too.

Limitations of this Law

The law of diminishing marginal utility applies only under certain
assumptions:

1. Homogeneous units – The different units of a commodity are

identical in all respects. The income, taste, temperament, habit,
etc. of the consumer also remains unchanged.
2. Standard units of consumption – The units of consumption
consist of standard units. If a man is thirsty, then water should
be given in units of a glass. If you give him a spoonful of water,
then the second spoon would conceivably have higher utility
than the first.
3. Continuous consumption – There is a continuous consumption
of units. That is, there is no gap between the consumption of two
units.
4. Not applicable to prestigious goods – The law does not apply to
prestigious goods like gold, cash, etc. where a greater quantity
can increase the lust for it.
5. Related goods – If you don’t have sugar, then you will consume
less tea. Hence, the utility of goods can be affected by the
absence of related goods.
 Conclusion
Marginal utility (MU) is defined as the additional (cardinal) utility

gained from the consumption of one additional unit of a good or

service or the additional (ordinal) use that a person has for an

additional unit. Using the same example, if the economic utility of the

first slice of pizza is ten utils and the utility of the second slice is

eight utils, the MU of eating the second slice is eight utils. If the

utility of a third slice is two utils, the MU of eating that third slice is

two utils. In ordinal utility terms, a person might eat the first slice of

pizza, share the second slice with their roommate, save the third slice

for breakfast, and use the fourth slice as a doorstop.

 Bibliography
The following sources were referred for preparation of this

assignment:

• https://www.utilitarianism.com/hedcalc.htm#:~:text=%22

• https://iep.utm.edu/util-a-

r/#:~:text=Utilitarianism%20is%20one%20of%20the,ba d%

20results%20that%20they%20produce

• ord.edu/entries/utilitarianism-history/
 Faculty of Law, Aligarh Muslim
University

2021

Economics
(Tutorial & Project Work)
On

‘Project Topic-The Concept of cost’

Submitted to;
Dr. Mohd. Rahmatullah

Submitted by;
SHREYANSH CHAUDHARY
Roll.No.- 20 BALLB 054
BA LLB III Semester (Section A)
Enrolment No.- GK 9302
Project

Work
 Introduction
It is a commonly accepted fact that physical inputs or resources are
important for enhancing production. We, however, tend to miss out on
the financial aspect of this rule. Some of the most important decisions
pertaining to business often relate to the cost of production, instead of
physical resources themselves. Hence, it is important for producers to
understand cost analysis. Let’s understand the general concept of
costs for that.

cost, in common usage, the monetary value of goods and services that
producers and consumers purchase. In a basic economic sense, cost
is the measure of the alternative opportunities foregone in the choice
of one good or activity over others. This fundamental cost is usually
referred to as opportunity cost. For a consumer with a fixed income,
the opportunity cost of purchasing a new domestic appliance may be,
for example, the value of a vacation trip not taken.

More conventionally, cost has to do with the relationship between the

value of production inputs and the level of output. Total cost refers to
the total expense incurred in reaching a particular level of output; if
such total cost is divided by the quantity produced, average or unit
cost is obtained. A portion of the total cost known as fixed cost—e.g.,
the costs of a building lease or of heavy machinery—does not vary
with the quantity produced and, in the short run, does not alter with
changes in the amount produced. Variable costs, like the costs
of labour or raw materials, change with the level of output.

Concept of Costs
In order to understand the general concept of costs, it is important to
know the following types of costs:

1. Accounting costs and Economic costs

2. Outlay costs and Opportunity costs

3. Direct/Traceable costs and Indirect/Untraceable costs

4. Incremental costs and Sunk costs

5. Private costs and Social costs

6. Fixed costs and Variable costs

 Concept of Costs in terms of
Treatment
1. Accounting costs

Accounting costs are those for which the entrepreneur pays direct
cash for procuring resources for production. These include costs of
the price paid for raw materials and machines, wages paid to workers,
electricity charges, the cost incurred in hiring or purchasing a
building or plot, etc. Accounting costs are treated as expenses.
Chartered accountants record them in financial statements.

2. Economic costs

There are certain costs that accounting costs disregard. These

include money which the entrepreneur forgoes but would have
earned had he invested his time, efforts and investments in other
ventures. For example, the entrepreneur would have earned an
income had he sold his services to others instead of working on his
own business
Similarly, potential returns on the capital he employed in his business
instead of giving it to others, the output generated by his resources
which he could have used for others’ benefits, etc. are other examples
of economic costs.

Economic costs help the entrepreneur calculate supernormal profits,

i.e. profits he would earn above the normal profits by investing in
ventures other than his.

Concept of Costs in terms of the

Nature of Expenses
1. Outlay costs

The actual expenses incurred by the entrepreneur in employing

inputs are called outlay costs. These include costs on payment of
wages, rent, electricity or fuel charges, raw materials, etc. We have
to treat them are general expenses for the business.

2. Opportunity costs
Opportunity costs are incomes from the next best alternative that is
foregone when the entrepreneur makes certain choices.

For example, the entrepreneur could have earned a salary had he

worked for others instead of spending time on his own business.
These costs calculate the missed opportunity and calculate income
that we can earn by following some other policy.

Concept of Costs in terms of

Traceability
1. Direct costs

Direct costs are related to a specific process or product. They are

also called traceable costs as we can directly trace them to a
particular activity, product or process.

They can vary with changes in the activity or product. Examples of

direct costs include manufacturing costs relating to production,
customer acquisition costs pertaining to sales, etc.

2. Indirect costs
Indirect costs, or untraceable costs, are those which do not directly
relate to a specific activity or component of the business. For
example, an increase in charges of electricity or taxes payable on
income. Although we cannot trace indirect costs, they are important
because they affect overall profitability.

Concept of Costs in terms of the

Purpose
1. Incremental costs

These costs are incurred when the business makes a policy decision.
For example, change of product line, acquisition of new customers,
upgrade of machinery to increase output are incremental costs.

2. Sunk costs

Suck costs are costs which the entrepreneur has already incurred and
he cannot recover them again now. These include money spent on
advertising, conducting research, and acquiring machinery.
 Concept of Costs in terms of
Payers
1. Private costs

These costs are incurred by the business in furtherance of its own

objectives. Entrepreneurs spend them for their own private and
business interests. For example, costs of manufacturing, production,
sale, advertising, etc.

2. Social costs

As the name suggests, it is the society that bears social costs for
private interests and expenses of the business. These include social
resources for which the firm does not incur expenses, like
atmosphere, water resources and environmental pollution.
 Concept of Costs in terms of
Variability
1. Fixed costs

Fixed costs are those which do not change with the volume of output.
The business incurs them regardless of their level of production.
Examples of these include payment of rent, taxes, interest on a loan,
etc.

2. Variable costs

These costs will vary depending upon the output that the business
generates. Less production will cost fewer expenses, and vice versa,
the business will pay more when its production is greater. Expenses
on the purchase of raw material and payment of wages are examples
 Conclusion
An aspect of cost important in economic analysis is marginal
cost, or the addition to the total cost resulting from the
production of an additional unit of output. A firm desiring to
maximize its profits will, in theory, determine its level of
output by continuing production until the cost of the last
additional unit produced (marginal cost) just equals the
addition to revenue (marginal revenue) obtained from it.

Another consideration involves the cost of externalities—that

is, the costs that are imposed either intentionally or
unintentionally on others. Thus the cost of generating
electricity by burning high-sulfur bituminous coal can be
measured not only by the cost of the coal and its transport to
the power plant (among other economic considerations) but
also by its cost in terms of air pollution.
 Bibliography
➢ William Baumol (1968), Entrepreneurship in Economic
Theory. American Economic Review, Papers and
Proceedings.

➢ Stephen Ison and Stuart Wall (2007), Economics, 4th

Edition, Harlow, England; New York: FT Prentice Hall.

➢ Israel Kirzner (1979), Perception, Opportunity and

Profit, Chicago: University of Chicago Press.