Economics

SUBMITTED TO DR. Adeel Saleem

Submitted by. Saima bibi

Roll no. BGRF18M017

CLASS B.S GEOGRAPHY 4TH

SUBJECT Introduction to Economics

Group 4th
Department of Earth Science

Date of submission 22th April , 2020

Mid term Exam assignment

Table of Content
¶ Explain the principle based on which a consumer spends his income
for getting maximum satisfaction .?
¶ Discuss its practical importance. ?

Who is consumer?
Consumer behavior ?
Consumer equilibrium?
Consumer equilibrium approaches?
 Cardinal approaches
 Ordinal approach
 The Reveled preferences approaches
What is utility?
Total utility
Marginal utility

¶ Law of EQUi Marginal utility

 Definition
 Approaches
 Statement
 Single commodity model
 Multiple commodity model
 Assumption
  Framework
 Table
 Diagram
 Criticism
 Importance
¶ Law of diminishing marginal utility
 Introduction
 Assumptions
 Exception / limitation
 Importance
 Basic sketch
Economy

production consumption

producer /firm consumer

supply demand

Maxi . profit maximum satisfaction

/Min. loss

Equilibrium Equilibrium

Optimization

Consumer economics 
 is a branch of economics. It is a broad field, principally concerned with microeconomic
analysis behavior in units of consumers, families, or individuals

(in contrast to traditional economics, which primarily government or business units)

Who is Consumer ?

The consumer is a person who uses the goods & services to meet economics want or needs that   person
are called consumer.

Consumption

The goods& services that are used by consumer to meet the economic need or wan thar goods are
called consumption

Types of consumptions

There are basically two types of consumptions

 Direct consumption

 Indirect consumption

Direct consumptions

The goods and services that can consumer can use it to get maximum satisfaction directly .that are
called Direct consumption

Example

Consumption of food ,clothes ,shoes, car motor bike etc.

Indirect consumption

The consumption of capital good or the good from which we get satisfaction indirectly that are called
indirect consumption .

Example

The use of machine , factories ,etc. that produce the consumer gooods.

 Consumer behavior
The behavior which a consumer or user can adopt to maximum satisfaction with in limited resources or
income that are called consumer behavior.
  Consumer ‘s equilibrium
The maximization of satisfaction with in the given condition of limited resources and unlimited wants
that are called consumer equilibrium

Equilibrium

The best possible situation within the given condition for a consumer.

Consumer’s equilibrium is a situation when he spends his given income on the

purchase of one or more commodities in such a way that he gets maximum satisfaction and
has no urge to change this level of consumption, given the prices of commodities

APPROACHES
There are basically three approaches in consumer equilibrium can be discussed.
 The cardinal approaches
 Ordinal approaches
 The revealed preferences approaches.

What is utility?
Utility is the power of goods and services to satisfy human wants ,.

It is the level of satisfaction which a consumer can obtain from consuming a goods and services with in a
specific time period.

That are called utility.

OR
Utility 

is a term in economics that refers to the total satisfaction received from

consuming a good or service. ...

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
Aspects of utility
Some important aspects of utility are as follow

 Total utility
 Marginal utility

Total utility
The utility obtained from all goods and services over a given a time period. That are called total utility

TU= ∑MU

Marginal utility
Net addition to the total utility due to the consumption of an extra units of goods is called marginal
utility.

MU =∆TU/∆Q
Table of various aspect of utility

Unit of commodity Total utility /TU Marginal utility/ MU

1 10 10
2 10+8=18 8
3 18+4=22 4
4 22+0=22 0
5 22-6=16 -6

 LAW OF DIMINISHING MARGINAL UTILITY

In economics,

the law of diminishing marginal utility …..states that the marginal utility of a

good or service declines as its available supply increases. Economic actors devote each
successive unit of the good or service towards less and less valued ends

EXAMPLE
Consuming one candy bar may satisfy a person's sweet tooth. If a second candy bar is
consumed, the satisfaction of eating that second bar will be less than the satisfaction gained
from eating the first. If a third is eaten, the satisfaction will be even less.

Introduction.

Major concern in this theory of consumer behavior ……….

Is to find consumer equilibrium like

consumer or user maximum satisfaction with In given condition .
Approaches

Consumer ‘s equilibrium can be discussed under the following approaches.

 The cardinal approaches

 The ordinal approaches
 The revealed preferences

The cardinal utility

At present we are concerned with the Law Of Diminishing marginal utility which provide sound
foundation to discuss consumer equilibrium under the cardinal utility approaches.

The pivot of the law under discussion is the concept of marginal utility.

Marginal utility

By marginal utility by means the Net addition to the total utility due to consumption of an Additional
unit of a particular goods and services.

 Founder of the law of dimensioning marginal utility

The founder of law of dimensioning marginal utility is Mr.Gossen . he is a German Economist ,

He was the first person that he explain this law in 1854

Later Alfred Marshal (1842-1924) refined this law and he is considered the major exponent of this law.

Statements

According to Dr. Alfred marshal

He state that in their famous book principle of Economics

The additional benefit which a person derives from an increase of his stock of a thing of diminish with
every increase in the stock.

According Paul A Samuelson

He says that … the consumed amount of of a goods increase , the marginal utility of that goods end to
decrease.

Comprehensively speaking .

Law of marginal utility state that ,

“ other thing being constant marginal utility of that goods or services continue to decrease with its
consecutive consumption ; it reach zero and if consecutive consumption of successive unit is
continued , it become negative ”

Example of Diminishing Utility

An individual can purchase a slice of pizza for $2; she is quite hungry and decides to buy five slices of
pizza………. After doing so, the individual consumes

 the first slice of pizza and gains a certain positive utility from eating the food.

Because the individual was hungry and this is the first food she consumed, the first slice of pizza has a
high benefit.

 Upon consuming the second slice of pizza, the individual’s appetite is becoming satisfied.
….. She wasn't as hungry as before, so the second slice of pizza had a smaller benefit and
enjoyment as the first.

 In fact, the fourth slice of pizza has experienced a diminished marginal utility as well, as it is
difficult to be consumed

because the individual experiences discomfort upon being full from food.

 Finally, the fifth slice of pizza cannot even be consumed. ..The individual is so full from the first
four slices that consuming the last slice of pizza results in negative utility.
..
 The five slices of pizza demonstrate the decreasing utility that is experienced upon the
consumption of any good

 Another example

 . In a business application, a company may benefit from having three accountants on its staff.
……..However, if there is no need for another accountant, hiring a fourth accountant results in a
 diminished utility, as little benefit is gained from the new hire The third slice, as before, holds
even less utility as the individual is now not hungry anymore.

Assumptions
Law of diminishing marginal utility is valid only with the following assumptions .

 Rationality

The basic assumption is that the consumer aim at maximization of satisfaction within the given
condition .

 Constant marginal utility of money

Purchasing power per unit of money for successive unit of money remain the same.

 Additive utility

Additive utility implies independent utilities of various goods in a given bundle which can be added to
fined total utility .

If there are N commodities in a bundle with the quantities x1 , x2 …..xn then utility function is

U = f(x1,x2,………………xn )

Total utility is additive

U = u1(X1) +u2(X2)+…………+Un Xn

 Homogeneous unit

All the successive unit to be consumed must be homogeneous in all respect like color packing size etc.

 Suitability quality
Suitability unit of commodity should ne consumed otherwise this law should be valid .

 No change in consumer attitude

Consumer attitude toward a commodity should remain a same otherwise this this law not be valid.

 No change in consumer taste

This law will not be valid if there is change in taste or fashion .

 No change in quality
Quality of successive unit should remain be the same .

For example if quality of successive unit improve this law should be valid .

 No change in price
In the case of decrease of price utility may increase for the successive unit .

This price should remain the same for the validity of this law. Moreover the price of substitute should
also remain the same.

 No change in consumer income

Change in consumer income bring about a change in purchasing power which may change the whole
scenario,.

Hence consumer ‘s income should remain the same.

 Divisibility
Commodity consumed should be divisible into smaller units .

 Framework
We cam illustrate this law with help of table

Unit of commodity Total utility /TU Marginal utility /MU

1 10 10
2 18 8
3 22 4
4 22 0
5 16 -6

10

 Diagram

5
 0 1 2 3 4 5

-6

Units of goods

Exception and limitation s

We observe the following exception or limitation of law of diminishing marginal utility.

* Money and wealth

The temptation of money and wealth has no end. So that this law is not applicable on money and
wealth.

* Knowledge

The person acquires more and more knowledge his thrust for knowledge increase and the utility of
further study also increase .

* Art

It has never perfection in art and true artist alwayes remain ambitions toward the perfections

* Rare collection

This law does not hold in case of collection of antique like diamonds old coins rare painting etc

* Power

This law does not hold for power and its externalities

* Taste for display

This law does not apply to thing or activities which satisfy a consumer taste for display of wealth or
prestigious status in society .

* Public goods

This law does not applicable in case of public goods as the utility of public goods like telephone
facility goes on increasing .

* Hobbies

This law does not be hold in case of personal hobbies like painting , ticket collecting etc.

* Narcotics

If a person is addicting to smoking , drinking , or drug , his utility for successive unit increase . hence
this law does not applicable to narcotics .

* Fashion and custom

This law become inoperative in case of fashion and customs.

Importance of law of diminishing marginal utility

Law of diminishing ,marginal utility is considered very important in economics literature on the basis of
following facts.

 Basis of the law of demand

(LDMU) Law of diminishing marginal utility provides the basis of the law of demands .when we have
higher stock of a commodity , its MU .. decrease and when MU decrease price of the good decrease
which in higher demands.

 Consumer equilibrium

It provide sound foundation to meet ultimate objective of a consumer such as maximum satisfaction
with in given condition .

 Consumer surplus

Consumer surplus is the difference b/w the price which he is willing to pay and what he actually pay.
it is the basically the difference b/w totally utility and the actually money spent.

Thus the concept of consumer is surplus is based on LDUM

 Taxation policy

LDMU reveals that MU of money for rich is less than poor. The finance minister seek help from this law
and imposes progressive tax.,

Which higher rate of tax is imposed on the rich and lower rate of tax is imposed on the poor.

 Redistribution of wealth

Marginal utility of money for the rich is lower than for the poor.

If some wealth is taken away from the rich minority and distributed among the poor majority .,

Total utility of the society increase . hence LDMU provides an indument for the redistribution of
wealth.

 Price determination

If supply of goods increase its MU decrease and as a result price also decrease . hence price is
determined in the light of this law .

 Value in exchanges

Value in exchanges is determined on the bases of the concept of marginal utility .

For example

Air has value in use but no marginal utility and as result no price.

On the other hand the goods which have MU , these goods have value in exchanges .

 Household expenditure

A rational household settles his expenditures in the light of LDMU.A

He does not spend even a single penny on the goods from which MU is less than price of that goods.

 Variety in production

Marginal utility of one product decreases sharply while the marginal utility of variety of products
decrease slowly.

Hence this law iduces the producers to supply a variety of commodities in the market.

 Conclusion
The above discussion reveals that LDMU is one of the basic laws of Economics literature .

It provide foundation stone for consumer equilibrium under classical approaches.

Moreover many other very important economics theories developed on the basis of this law .

Law of EQUE marginal utility

The law of equi-marginal utility ………

states that the consumer will distribute his money income between the goods in such a way that
the utility derived from the last rupee spend on each good is equal. In other words, consumer is in
equilibrium position when marginal utility of money expenditure on each goods is the same

Law of Equi-Marginal Utility explains the relation between the consumption of two or more products
and what combination of consumption these products will give optimum satisfaction.

Marginal Utility is the additional satisfaction gained by consuming one more unit of a commodity.

* Introduction

Major focus in the theory of consumer behavior is to find consumer equilibrium

Like ……… maximum satisfaction within given condition . consumer equilibrium can be discussed under
the following approaches

¶ The cardinal utility approaches

¶ The ordinal utility approaches
¶ The revealed preferences
 Consumer equilibrium under two head

Law of equi marginal utility are explain under two head

 Single commodity model

 Multi commodity model

 Single commodity model

Other thing remain the same a consumer gets equilibrium if and only if marginal utility of thte
commodities purchased is equal to the price of the commodities.

 Multi commodity model

Other thing remain the same a consumer get equilibrium if and only if marginal utility per unit of money
of all the commodities purchased is equal.

 Assumptions law of EQUI marginal utility

The law of equi marginal utility is based on the following assumptions

 Substitutability
Commodities can be substituted with one on other for minimization of utility

 Comparability
The utility derived from the commodities and its price is comparable in a single commodity model .

Similarly the ratios b/w the marginal utility and relative prices of different commodities can bbe
compared in case of multi –commodities

 Prefect knowledge
Consumer have prefect knowledge of utility obtained from goods and relative prices .

 Rationality
The basic assumption is that the consumer aim at maximization of satisfaction within the given
condition .
  Constant marginal utility of money
Purchasing power per unit of money for successive unit of money remain the same.

 Additive utility
Additive utility implies independent utilities of various goods in a given bundle which can be added to
fined total utility .

If there are N commodities in a bundle with the quantities x1 , x2 …..xn then utility function is

U = f(x1,x2,………………xn )

Total utility is additive

U = u1(X1) +u2(X2)+…………+Un Xn

 Homogeneous unit
All the successive unit to be consumed must be homogeneous in all respect like color packing size etc.

 Suitability quality
Suitability unit of commodity should ne consumed otherwise this law should be valid .

 No change in consumer attitude

Consumer attitude toward a commodity should remain a same otherwise this this law not be valid.

 No change in consumer taste

This law will not be valid if there is change in taste or fashion .

 No change in quality
Quality of successive unit should remain be the same .

For example if quality of successive unit improve this law should be valid .

 No change in price
In the case of decrease of price utility may increase for the successive unit .

This price should remain the same for the validity of this law. Moreover the price of substitute should
also remain the same.
  No change in consumer income
Change in consumer income bring about a change in purchasing power which may change the whole
scenario,.

Hence consumer ‘s income should remain the same.

 Divisibility
Commodity consumed should be divisible into smaller units .

Other Assumptions of Law of Equi-Marginal Utility

 There is no change in the prices of the goods.

 The income of consumer is fixed.
 The marginal utility of money is constant.
 Consumer has perfect knowledge of utility obtained from goods.
 Consumer is normal person so he tries to seek maximum satisfaction.
 The utility is measurable in cardinal terms.
 Consumer has many wants.

The goods have substitutes

 . Units of goods are homogenous.

 No time gap between the consumption of the different units.
 Tastes, fashion, preferences, and priorities remain unchanged.
 Consumer aims at maximum satisfaction.
 Consumer’s income is fixed and limited

Framework
 Single commodity model

If a consumer purchased only one commodity like a commodity A he will be in equilibrium when he
observed that MUa = Pa

 If MUa >Pa

A rational consumer purchased more units of commodity to maximize his total utility . as a result MUa
decreases in the light of LDMU and finally the consumer can avail the equilibrium condition .
  If MUa <Pa

A rational consumer purchased less unit of the commodity to avail the equilibrium condition .as a result
MUa increase and the consumer can enjoy maximum total utility .

 Multiple commodity model.

If a consumer is interested to purchased more than one commodity , than he well be in equilibrium
when he satisfy the following condition simultaneously .

¶ Necessary condition

He must spend all the planed income to purchased the scheduled commodity .

In other word he must satisfy the following budget constraint equation .

PaA+PaBB+……PnN=I

Pa= price of commodity A

Pb = price of commodity B

I= CONSUMER INCOME TO BE SPENT

A=unit of commodity A to be purchased

B = unit of commodity B to be purchased

¶ Sufficient condition

Marginal utility per unit of money for all the commodity purchased should be equal.

MUa/Pa = MUb/Pb=MUc/Pc …………………..=MUn/pn

MUa/Pa =

Marginal utility per unit of money for commodity A

MUb/Pb =

Marginal utility per unit of money for commodity B

MUn/Pn

Marginal utility per unit of money per unit of good per nth commodity
Example
 Consumer purchased only two goods A&B
 Total planned income for the purchased of scheduled goods I=RS 1000
 Price of a good A Pa =RS 200 per unit
 Price of good B Pb = RS 100 Per unit.

Table

Unit of MUa MUb MUa/Pa MJUb /Pb

commodity
1 1000 600 5 6
2 800 5000 4 5
3 600 400 3 4
4 400 300 2 3
5 200 200 1 2
6 0 100 0 1

The table show that consumer enjoy equilibrium maximum utility

 if and only if he meets both the condition necessary condition and sufficient condition
simultaneously
 if he meet only the necessary condition and does not meet sufficient condition he will not be
able to avail equilibrium
 when consumer observed both the condition

table show that consumer meet both the condition of law of EQUI marginal utility

 if he purchased 3 units of goods A

 4 unit of good B
 PaA+PbB=I
200(3)+100(4)=1000
1OOO=1OOO

Necessary condition is met

  MUaa/Pa= MUb/Pb
600/200= 300/100= 3

Sufficient condition is met

 Now the consumer can avail the total utility as under

 TUa= 1000+800+600=2400 utits
 TUb= 600+500+300 =1800 utils
 TUa+b= 2400+1800=4200 utils

It is the maximum total utility within the given condition

It is possible only when the consumer follow both the condition of law of EQUI marginal utility

 When the consumer does not observe both the condition

If a consumer observe only necessary condition and does not meet the sufficient condition

He is unable to enjoy the maximum total utility .

As the table shown the consumer can purchased

 4 unit of goods A
 2 unit of goods B

Necessary condition is met

 PAa +PBb=I

200(4)+100(2)=1000

800+200=1000

1000=1000

Sufficient condition is not met

 MUa /Pa = MUb/Pb

400/200 = 500/100

2 =5

 if consumer follow the following strategy his total utility will be as under
 TUa=1000+800+600+400= 2800 utils
 TUb =600+500=1100 utils
  TUa+b=2800+110=3900 utils

3900 utils<4200 utills

Diagram

1000 MUa

900

800

700

MUb 600

500

400 Gain

Loss 300 +400

-700 200
100

6 5 4 3 2 1 0 1 2 3 4 5 6

Units of goods B units of goods A

  Another example

The law of substitution can be explained with the help of an example. Suppose consumer has six dollars
that he wants to spend on apples and bananas in order to obtain maximum total utility.

The following table shows marginal utility (MU) of spending additional dollars of income on apples and
bananas:

Money (Units) MU of apples MU of bananas

1 10 8
2 9 7
3 8 6
4 7 5
5 6 4
6 5 3

The above schedule shows that consumer can spend six dollars in different ways:

 $1 on apples and $5 on bananas. The total utility he can get  is:

[(10) + (8+7+6+5+4)] = 40.

 $2 on apples and $4 on bananas. The total utility he can get is:

[(10+9) + (8+7+6+5)] = 45.

 $3 on apples and $3 on bananas. The total utility he can get is:

[(10+9+8) + (8+7+6)] = 48.

 $4 on apples and $2 on bananas. This way the total utility is:

[(10+9+8+7) + (8+7)] = 49.
  $5 on apples and $1 on bananas. The total utility he can get is:
[(10+9+8+7+6) + (8)] = 48.

Total total utility for consumer is 49 utils that is the highest obtainable with expenditure of $4 on apples
and $2 on bananas. Here the condition MU of apple = MU of banana i.e 7 = 7 is also satisfied. Any other
allocation of the last dollar shall give less total utility to the consumer.

The same information can be used for graphical presentation of this law:
The diagram shows that consumer has income of six dollars. He wants to spend this money on apples
and bananas in such a way that there is maximum satisfaction to the consumer

Criticism
Law of EQUE marginal utility is bound to the following limitations

 Utility is not measureable :

Utility is a physical and mental phenomena and a consumer cannot add , compare, or equalize utility

 Fashion & customs

The people are the slaves of fashion and customs and the don’t bother to follow this law in case of
fashion and custom

 Indivisibility
Some good are indivisible which make this law inoperative

 Unawareness
Sometime customer is unaware of batter substitute due to which this law is invalid

 Carelessness
This law remain invalid due to carelessness and negligence of the customer.
  Freedom of choice
This become invalid due to constrains in freedom of choice

 Incomparable
The utility of perishable good and durable goods cannot be compared

 Variability of factors
The basic factor involving this law like price , consumer ,income, taste, are variable and not fixed factors

 Constant calculation …… not possible

This law is valid only when a consumer make a constant calculation of price .MU

Which is not possible.

 Demonstration effects
This law remain invalid incase of demonstration effects

 Unavailability of substitute
Substitute of goods play key role in his law but unavailability of substitute of goods

 Non homogeneity of units

The unit of some good may or may not homogenous . incase of non homogeneity of units

So that this law does not hold

 The law is not applicable in case of knowledge. Reading of books provides more satisfaction and
knowledge to the scholar. Different books provide variety of knowledge and satisfaction.

 The law is not applicable in case of indivisible goods. The consumer is unable to divide the goods
to adjust units of utility derived from consumption of goods

 There is no measurement of utility. It is psychological concept. It is not possible to express it into

quantitative form.
 The law does not hold well in case fashion and customs. The people like to spend money on
birthdays, marriages and deaths.

 The does not hold well in case of very low income. The maximization of utility is not possible due
to low income.

 The law is not applicable in case of durable goods. The calculation of marginal utility of durable
goods is impossible.

 The law fails when goods of choice are not available. The consumer is bound to use commodity,
which provides low utility due to non availability of goods having high utility.

 There are certain lazy consumers. They do not care for maximum utility. The law fails to operate
in case of laziness of consumers. They go on consuming goods with comparing utility.
 It does not work when there are frequent prices changes. The consumer is unable to calculate
utility of different commodities. Changing price levels create confusion in the minds of
consumers.

 There may be unlimited resources. The does not work due to unlimited resources. There is no
need to change the direction of expenditure from one item to another when there are gifts of
nature

importance:

 The law of equi marginal utility is helpful in the field of production. The producer has limited
resources. He uses limited resources to purchase production factors. He tries to equalize
marginal utility of all factors. He wishes to get maximum output and profit.

 National income is distributed among factors of production according to this law. An entrepreneur
can pay factors of production equal to marginal product measured in money terms. He will
 substitute one factor for another until marginal productivity of all factors is equal to prices of their
services.

 The law is used in the field of exchange. The people like to exchange a commodity having low
utility with a commodity having high utility. There is maximum benefit from exchange of
commodities. The law is helpful in exchange of wealth, trade, import and export.

 The law is applicable in consumption. A rational consumer tries to get maximum satisfaction
when he spends his limited resources on various things. He tries to equalize weighted marginal
utility of all the things.

 The law is applicable in public finance. The government can spend its revenue to get maximum
social advantage. The marginal utility of each dollar spent in one sector must be equal to
marginal utility derived from all other sectors.

 The law is useful for workers in allocating the time between work and rest. They can compare the
marginal utility of work and the marginal utility of rest. They can decide working hours and rest
hours.

 The law holds well in case of saving and spending. The consumer can make choice between
present wants and future wants. He can feel that a dollar saved has greater utility than a dollar
spent, he can save more and spend less. He will substitute saving and spending till marginal
utility of a dollar spent and a dollar saved are equal.

 The law is helpful in prices. Due to scarcity of commodity its prices go up. The law tells us to use
substitute commodity, which is less scarce. The result is that the price of commodity comes
down.
References
 www.managestudy.com
 www.topper.com.business>economcs
 http://www.yourarticlelibrary.com/economics
 www.economicsdiscussion.net (Law of Equi-Marginal Utility (With Diagrams)

 www.economicsdiscussion.net ›
 ...owlcation.com › Social Sciences › Economics
 - Forestrypediaforestrypedia.com ›

 SlideSharewww.slideshare.net › puttuguruprasad

Major part of this assignment is from text book

(economics b.com part 1)
6th edition

DR. SHABBIR AHMAD CONDAL)