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MANAGERIAL ECONOMICS

INDORE MANAGEMENT INSTITUTE

MBA I SEM.

Session 9: Why demand curve slopes


downwards

Objectives : To understand 1. Law of Diminishing Marginal Utility 2. Assumptions and Criticisms of DMU 3. Significance of Diminishing Marginal Utility
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4. Other Reasons

Law of Demand

Why Demand Curve Slopes Downwards ?

Traditional Approach:
1 The Law of Diminishing Marginal Utility: Propounded by Alfred Marshall. The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has

2 CHANGE IN THE NUMBER OF CONSUMERS: If a commodity becomes cheaper consumers increases and vice versa.
3 DIVERSE USES OF A COMMODITY: Ex. Electricity

Modern Approach:
1 Income Effect : Any change in the price of a commodity affects purchasing power of a household. 4

2 Substitution Effect: Ex. Tea and Coffee.

Assumptions of the Law of Diminishing Marginal Utility

Assumptions:
Total wants are unlimited but a single want is satiable.

Different goods are not perfect substitutes of each other.


Various Units are Homogeneous both qualitatively and quantitatively. There is no time gap between consumption of different units. Consumer is rational . Other Things remain constant like tastes, preferences etc.

Utility is Measurable and Quantifiable .

Criticisms of the Law of Diminishing Marginal Utility Cardinal Measurability of Utility is unrealistic : Psychic feeling and comparability can be done not measurement. Hypothesis of Independent Utility is wrong: Due to complementary or substitute goods . Marginal Utility of Money is not constant : It increases or decreases with the decline or increase in money. Successive units to be consumed at a particular point of time .

Other Things may not remain constant or unchanged.


Goods may not be homogeneous in all respects. Based on Observation rather than scientifically tested.

Does not split price effect into income and substitution effect.

Law of Diminishing Marginal Utility

As you consume more and more ,utility goes on diminishing .A consumer tries to maximize his satisfaction by equalising the marginal utility of the commodity with its price and is being attained sooner at Higher price. As total utility is maximum, marginal utility is zero or negative. By adding all the marginal utility , we can calculate the total utility.
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Helps in theory of Demand.

Significance of Law of Diminishing Marginal Utility

Determination of the Prices of Commodities.

Helps in understanding Paradox of Value:


Water and Diamond.

Why demand curve slopes downwards ?


2 CHANGE IN THE NUMBER OF CONSUMERS: If a commodity becomes cheaper, the consumers will increase and if the commodity becomes costlier the consumers will decrease. Thus the change in no of consumer effects the demand curve 3 DIVERSE USES OF A COMMODITY: If the commodity can be put to use for diverse uses and the price falls, the consumer increases the demand and vice versa.
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Why demand curve slopes downwards ?

Modern Approach:
1 Income Effect : Any change in the price of a commodity increases or decreases the purchasing power of a household. 2 Substitution Effect: Ex. Tea and Coffee.

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