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• Want-satisfying capacity of good is called utility. • Some important characteristics of utility
– – – – – – Utility and usefulness are different Consumption may not give pleasure Utility is not inherent property of any good Utility has no legal or moral implication Utility and satisfaction are not synonyms Utility is subjective - Place Utility - Service Utility
• Types of Utility
– Form Utility – Time Utility
Diminishing Marginal Utility
Total and Marginal Utility
• Marginal Utility refers to addition to total utilities consequent upon the consumption of one more unit of the same commodity at that moment of time. • It signifies the addition made to total utilities by the addition of one more unit of the same commodity. • Total utilities on the other hand signify the sum total of all the marginal utilities that a consumer may have derived from different but successive units of the same commodity at the same time.
Table Showing Difference Between Total and Marginal Utility
Number Total Utility Marginal of Units (in units) Utility (in units) 1 2 3 4 5 6 15 26 34 38 38 35 15 11 8 4 0 -3
Total Utility = Addition of marginal utilities at every successive stage Marginal Utility = Utility obtained separately from every successive unit or addition made to the total utility by the addition of one more unit of the same commodity at the same time and place.
Law of Diminishing Marginal Utility
• Dr. Marshall states the law as, “ 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.” • The theory is based on following assumptions
– Ceteris paribus (consumption of other things remaining constant) – Homogeneity of units – Time lag between consumption of two units.
• The Diminishing Marginal Utility can be understood with the help of following two statements:
– The more we have of a commodity the less and less we want to have more of the same commodity – The more we have of a commodity the more we want to have less and less of the same commodity.
• • At point R marginal and total utility are equal because it is the point of origin of both total and marginal utility. Between points R and Z, the marginal utility is declining but continues to be positive and therefore the total utility goes on increasing. At point Z, the marginal utility becomes zero at which the total utility becomes maximum, as is shown by the point M Below the point Z, marginal utility becomes negative and therefore total utility starts declining from and beyond the point M at which total utility has become maximum.
Total and Marginal Utility
M Total Utility Curve
Marginal Utility Curve
Units of the commodity consumed
Exceptions to the Law of Diminishing Marginal Utility
• Rare Articles • Hobbies like listening music, playing video games etc. • Drunkards • Greed for amassing power (political, economic, or social)
• The theory tries to explain how a consumer with limited income, wanting to consume more than one commodities and aiming at maximizing his satisfaction allocates his resources rationally on different goods and services. • According to the law, the consumer should spend his income on various goods and services in such a manner that the marginal utility he obtains from each one of them is equal. • Equation:
MUx Px = MUy Py = MUz MUn = …. = Pz Pn
• Suppose a consumer has Rs. 10 to spend on three commodities and the price of each commodity is Rs.1, then:
Units MU of A MU of B MU of C
1 2 3 4 5 6 18 16 14 12 10 8 14 12 10 8 6 4 12 10 8 6 4 2
• Utility is a psychological and subjective phenomena and cannot be measured correctly. • Just takes into consideration the substitute goods and not complementary goods. • Indivisible goods. • The assumption about the constancy of customs, tastes, fashions and other variables does not hold good in real world. • Marginal utility of money is taken as constant.
• In general sense we mean market is any place where consumers go with money to purchase the goods or services required by them and the seller of that goods or services are there to fulfill the need of the customers by charging money. Following are some of the definitions of market: • According to Sidgwick, “A market is a body of persons in such commercial relations that each can easily acquaint himself with the rates at which certain kinds of exchange of goods or services are from time to time made by the others.” • According to Benham, “market is any area over which buyers and sellers are in close touch with one another, either directly or through dealers, that the price obtainable in one part of the market affects the prices paid in other parts.”
Classification of Market
• • • • Area: local, regional, national, international Nature of transaction: Spot and futures Volume of business: wholesale and retail Time: very-short period, short period and long period market • Status of seller: primary, secondary, terminal • Regulation: Regulated and unregulated • Market structure: Perfect, monopoly, monopolistic, oligopoly, duopoly, monopsony.
• The opportunity cost of any commodity is the next best alternative commodity that is sacrificed or foregone. For example, the factors of production which are used for the manufacture of a car may also be used for production of machinery or any other equipment. • As Marshall said, “ The real ultimate cost of anything is the loss of that alternative which must be sacrificed when resources of any kind are devoted to a particular object.”
– Not applicable to items which can be put to only one use – Perfect competition and perfect mobility of factors – Subjective concept.
Explicit and implicit costs
• Economic costs are classified into two parts: explicit and implicit costs. • The former, also called, out-of-pocket costs, stands for the payments that must be made to the factors hired from outside the control of the firm. • In contrast, implicit costs, also known as book cost or non-cash costs, refer to the payments made to (or opportunity cost of) the self-owned resources used in the production. • For example, if a farmer produces 10 tonnes of wheat by employing seed of Rs. 750, labor Rs. 1900, Tractor charges Rs.2000, Fertilizer Rs. 1100, irrigation of Rs. 1250, and self owned factors like family labor and land worth Rs. 3500 and Rs. 5000 respectively. Now in this case explicit cost of wheat production is Rs. 7000 and its implicit cost is Rs. 8500. the only difference between these two cost concepts is in terms of whether the amount spent is on hired factors of on self-owned ones; alternatively, whether it involves cash payments or merely a book cost.
Relationship between Average Cost and Marginal Cost:
• 1. The relationship between average cost and marginal cost may be stated as follows: When average cost is falling, the marginal cost is lower than the average cost. In this case marginal cost curve is below the average cost curve. When average cost is rising, the marginal cost is higher than the average cost and therefore the marginal cost curve is above the average cost curve. When it comes to falling, the marginal cost curve falls more rapidly than the average cost curve, and when it comes to rising the marginal cost curve rises more rapidly than the average cost curve. When average cost is minimum, marginal cost and average cost are equal. At this point the marginal cost curve cuts the average cost curve from below at the lowest point.
MC AC P
MC AC MC MC
Short Run Cost Concepts
• Short run total fixed cost: addition of cost of all the fixed assets • Short run total variable cost: cost per unit * Q • Short run total cost: TFC + TVC • Average fixed cost: TFC / Q • Average variable cost: TVC / Q • Short run Average cost: AFC + AVC • Marginal cost: ∆ TC / ∆ Q **Q = Output
• Dr. Marshall defines land as, “ By land is meant not merely land in the strict sense of the word, but whole of the materials and forces which nature gives freely for man’s aid in land, water, in air and light and heat.” • Characteristics:
– – – – – Free gift of nature Limited in area Permanent No mobility Infinite variety
• According to Marshall labor is, “ any exertion of mind or body undergone partly or wholly with a view to earning some good other than the pleasure derived directly from the work. • Features:
– – – – – – – – – Inseparable from laborer Sells service not himself More perishable than any other commodity Less bargain power Not machine (having feelings and emotions) Less mobile Supply independent of demand Difficulty in calculating cost of production Differ in efficiency
• Defined as that part of a person’s wealth, other than land, which yields an income or which aids in the production of further wealth.
• To bring the factors of production together, assign each its proper task, and pay them remuneration when the work is done. • Functions of an entrepreneur
– – – – – – Conceiving and initiating Organizing Directing and supervising Control Risk-taking innovation
Law of Variable Proportions
• In economics, the production function with one variable input is illustrated with the well-known Law of Variable Proportions. The law of variable proportion is one of the fundamental laws of economics. It has also been called as the law of diminishing marginal returns (also sometimes known as Law of Diminishing Marginal Productivity). • One factor fixed and other variable • In short-run, input-output relations are studied with one variable input (labor), other inputs (especially capital) held constant.
Assumptions of The Theory
• Constant technology: If technology changes, marginal and average product may rise instead of diminishing. • Short run: The law operates in the short run because it is here that some factors are fixed and others are variable. In the long run, all factors are variable. • Homogeneous inputs: The variable input as applied unit by unit is homogeneous or identical in amount and quality. • It is possible to use various amounts of a variable factor on the fixed factors of production.
Law of Variable Proportions
Total Physical Marginal Product Physical Product
Average Physical Product
Increases at an Increases, Increases and increasing rate reaches its reaches its maximum and maximum then declines till MP = AP
Negative returns AP
Increases at a Is diminishing Starts diminishing rate and becomes diminishing till it reaches equal to zero maximum
Maximum Average Product
Starts declining Becomes negative Continues to decline