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ME (Unit-3)
ME (Unit-3)
Cardinal Utility of
Demand
What is Utility?
time.
Measurement ‘Utils‟
Subjective entity
Measuring Utility
Utility Analysis
• Alfred Marshal
Subjective.
Relative.
Usefulness, and.
Morality.
Types of utility
Total Utility
Marginal Utility
Total Utility
• Example: A consumer consumes 3 units of X and derives utility u1, u2, u3 and
u4
MU = TU/ X
Table : Total Utility (TU) and Marginal Utility (MU)
2 36 16
3 46 10
4 50 4
5 50 0
6 44 -6
Laws of Utility Part 1
Law of Diminishing Marginal Utility
utility.
are as follows:
2 36 16
3 46 10
4 50 4
5 50 0
6 44 -6
Graphical Expa of the law
Explanation of Example
• In Figure in the previous slide, units of ice-cream, are shown along the X-axis
and TU and MU are measured along the Y-axis. MU is positive and TU is
increasing till the 4th ice-cream. After consuming the 5th ice-cream, MU is zero
and TU is maximum.
7th Icecream
Laws of Utility Part 2
Law of Equimarginal Utility
•The law is not applicable in case of knowledge. Reading books provides more knowledge
•The law fails when there are no choices available for the good.
This law is helpful in the field of production. A producer has limited resources and tries to get
maximum profit.
This law is helpful in the field of exchange. The exchange is of anything like some goods,
The law is useful for workers in allocating the time between the work and rest.
The concept of indifference curve was first developed by British economist Francis Ysidro
Edgeworth and was put into use by Italian economist Vilfredo Pareto during the early 20th
century.
An indifference curve is a graph showing combination of two goods that give the consumer
equal satisfaction and utility.
Each point on an indifference curve
Indifference Curve
The indifference curve theory is based on some assumptions. These assumptions are –
Two Commodities: It is assumed that the consumer has fixed amount of money, all of which is
to be spent only on two goods while prices of both goods are constant.
Non Satiety: Satiety means full satisfaction. Indifference curve theory assume that the
consumer has hot yet reached the point of satiety. It implies that the consumer still has the will to
consume more of both the goods.
Ordinal Utility: According to this theory, utility is a psychological phenomenon and thus it is
unquantifiable. However, the theory assumes that a consumer can express utility in terms of
rank. The consumer can do it by the basis of satisfaction yielded from each combination of
goods.
Assumptions of Indifference Curve
Diminishing Marginal Rate of Substitution: Marginal rate of substitution may be defined as the
amount of a commodity that a consumer is willing to trade off for another commodity, as long
as the second commodity provides the same level of utility as the first one.
Rational Consumer: A consumer always behaves in a rational manner, i.e. a consumer always
In economics, the marginal rate of substitution (MRS) is the amount of a good that a
consumer is willing to consume in relation to another good, as long as the new good is equally
satisfying.
Marginal rates of substitution are graphed along an indifference curve which is usually
The MRS is the slope of the indifference curve at any given point along the curve.
Example of MRS
For example, a consumer must choose between Coke and hot dogs. In order to determine the
marginal rate of substitution, the consumer is asked what combinations of Coke and hot dogs
provide the same level of satisfaction.
When these combinations are graphed, the slope of the resulting line is negative. This means that
the consumer faces a diminishing marginal rate of substitution: the more Cokes they have
relative to hot dogs, the fewer hot dogs they are willing to consume.
Limitations of Marginal Rate of Substitution
MRS does not necessarily examine marginal utility since it treats the utility of both
comparable goods equally though in actuality they may have varying utility.
Relationship Between MRS and Marginal Utility
Revealed Preference
Theory
Revealed Preference theory of demand
• This theory relies on the market behaviour of the consumer to know about his
preferences with regard to the various combinations for the two reactions and
The income of the consumer, prices of the two commodities are constant during
the period of analysis
The tastes of the consumer are given and remain unchanged during the period of
analysis
The consumer should choose only one combination of the commodities in a given
price-income situation .
substantial cut
The choice of the consumer reveals his preference and market behaviour of the consumer
Transitivity states that no two observations of choice behaviour can conflict with regard to an
When a consumer purchases some commodities either because, he likes them more than other
Assuming that both the commodities are equally same cost and are equally good
If the consumer buys X combination rather than Y commodity, because he like X combination
More realistic
More scientific
More consistent
•It provides an insight into upcoming cash flow, meaning businesses can
more accurately budget to pay suppliers and other operational costs, and
invest in the growth of the business.
Need of Demand Forecasting
•Through sales forecasting, you can also identify and rectify any kinks in
the sales pipeline ahead of time to ensure your business performance
remains robust throughout the entire period.
Quantitative Method
1. Consumers interview method: Under this method, efforts are made to collect
the relevant information directly from the consumers with regard to their future
purchase plans.
ii. Sample survey method or the consumer panel method: Under this
method, different cross sections of customers that make up the bulk of the
market are carefully chosen. Only such consumers selected from the relevant
market through some sampling method are interviewed or surveyed.
Qualitative methods of Demand Forecasting
Focus Groups: To use a focus group, you need to find a representative
group of your potential customers. You then sit them all down in a
comfortable group setting and talk with them. You find out what products they
currently use for cookie cutters, how satisfied they are with them, what
improvements they would like to see, how likely they are to purchase a new
product, and how much they would be willing to pay.
Qualitative methods of Demand Forecasting
Collective opinion method or opinion survey method: Under this
method, sales representatives, professional experts and the market
consultants and others are asked to express their considered opinions
about the volume of sales expected in the future.
End Use or Input – Output Method: Under this method, the sale of the
product under consideration is projected on the basis of demand surveys of
the industries using the given product as an intermediate product.
Qualitative methods of Demand Forecasting
Delphi Method or Experts Opinion Method: Under this method, outside experts
are appointed. They are supplied with all kinds of information and statistical data.
The management requests the experts to express their considered opinions and
views about the expected future sales of the company.
Techniques of
Demand
Forecasting-
Quantitative
Techniques-Part 1
Quantitative methods of Demand Forecasting
Quantitative Method: It is the second most popular method of demand
forecasting. It is the best available technique and most commonly used
method in recent years. Under this method, statistical, mathematical models,
equations etc are extensively used in order to estimate future demand of a
particular product. They are used for estimating long term demand. They are
highly complex and complicated in nature.
Qualitative methods of Demand Forecasting
Trend Projection Method: An old firm operating in the market for a long
period will have the accumulated previous data on either production or
sales pertaining to different years. If we arrange them in chronological
order, we get what is called „time series This method is not based on any
particular theory as to what causes the variables to change but merely
assumes that whatever forces contributed to change in the recent past will
continue to have the same effect. On the basis of time series, it is possible
to project the future sales of a company.
Qualitative methods of Demand Forecasting
Economic Indicators: Under this method, a few economic indicators
become the basis for forecasting the sales of a company. An economic
indicator indicates change in the magnitude of an economic variable. It
gives the signal about the direction of change in an economic variable. This
helps in decision making process of a company
Qualitative methods of Demand Forecasting
Causal Demand Forecasting Method: This method is used to produce a
demand forecasting models based on the existence of a substantial cause
and effect relationship between explanatory variables (i.e., independent
variables) and the demand variable itself (i.e., dependent variable)
(Armstrong and Green 2012). Depending on the depth of knowledge of the
variables affecting the situation of interest (i.e., demand) and availability of
data, causal methods may have the following branches: regression
analysis, the index method, and segmentation (Armstrong and Green
2012).
Qualitative methods of Demand Forecasting
Advantages of Causal Forecasting
Possess explanatory powers.
Allows for the execution of if forecasting by exploring the interaction
among demand variables.
Acts as a valuable tool for planners, marketers, and strategists.
Allows the forecasting of the effect of policy changes such as price
changes and promotions.
Quantitative methods of Demand Forecasting
Time Series Demand Forecasting Method:
For this method to work, the variable to undergo forecast must have
consistently shown specific unique patterns in a past time horizon and that this
identified pattern will be sustained into the future (Anonymous 2011; Brockwell &
Davis 1986). These patterns can either be cyclical, seasonal or periodic (Taylor
2008).
Time series collected at regular intervals are then used to produce models. The
time series method is most applicable when there is a lack of a distinct upward or
downward pattern in the historical data being explored, showing an absence of a
linear relationship between demand and time (Armstrong and Green 2012).
Moving Average, Exponential smoothing, and Trend projections are all offshoots
of the Time Series method of demand forecasting.
Qualitative methods of Demand Forecasting
Time series models: The model assumes that the information needed to
generate a forecast is included in time series of data. A time series here, is
a set of observations taken at regular intervals over a specified period of
time. Different techniques which are based on this model are:
•Naive Forecast: Uses last period's actual demand value as the forecast
for current period.
•Simple Mean Forecast: Simply sums up the demand values and finds the
mean. The mean value is taken as the forecast for the next period.
Qualitative methods of Demand Forecasting
•Simple Moving Average Forecast: Finds the mean but, considers only
specified time period. For ex: 3 months moving average will find the mean
of the recent 3 months data for the forecast.