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Utility

• Want-satisfying capacity of any


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
• Types of Utility
– Form Utility - Place Utility
– Time Utility - Service 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 Total Utility = Addition of marginal
units) utilities at every successive stage
1 15 15 Marginal Utility = Utility obtained
2 26 11 separately from every successive unit
3 34 8 or addition made to the total utility by
4 38 4 the addition of one more unit of the
same commodity at the same time and
5 38 0
place.
6 35 -3
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.
Graphical Presentation
• At point R marginal and total utility are
equal because it is the point of origin

Total and Marginal Utility


of both total and marginal utility.
• Between points R and Z, the marginal M
utility is declining but continues to be
positive and therefore the total utility Total Utility
Curve
goes on increasing. R
• At point Z, the marginal utility
becomes zero at which the total utility
becomes maximum, as is shown by the
point M Z
• Below the point Z, marginal utility
Marginal
becomes negative and therefore total Utility Curve
utility starts declining from and beyond Units of the commodity consumed
the point M at which total utility has
become maximum.
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)
Equi-marginal Utility
• 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 MUy MUz MUn


= = = …. =
Px Py Pz Pn
Illustration
• 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 18 14 12
2 16 12 10
3 14 10 8
4 12 8 6
5 10 6 4
6 8 4 2
Critical Evaluation
• 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.
Market
• 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.
Opportunity Cost
• 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.”
• Limitations:
– 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:
• The relationship between average cost and marginal
cost may be stated as follows:
1. When average cost is falling, the marginal cost is MC
lower than the average cost. In this case marginal cost
AC
curve is below the average cost curve.
2. When average cost is rising, the marginal cost is
higher than the average cost and therefore the P
marginal cost curve is above the average cost curve.
3. 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. Output
MC
4. 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 AC MC
lowest point. 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
LRAC Curve

SRAC’ SRAC’”
SRAC”
LRAC
A C
B

0 D E F
Output
Land
• 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
Labor
• 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
Capital
• 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.
Entrepreneur
• 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 Total Physical Marginal Average

Proportions Product Physical


Product
Physical
Product

Stage I
Increases at an Increases, Increases and
increasing rate reaches its reaches its
maximum and maximum
then declines till
MP = AP
TP
Stage 1 Stage 2 Stage 3 Stage II
Increasing Decreasing Negative Increases at a Is diminishing Starts
returns returns diminishing rate and becomes diminishing
returns till it reaches equal to zero
maximum
AP

Maximum MP Stage III


Average Starts declining Becomes Continues to
Product negative decline

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