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### Lecture5

1. 1. Lecture #5 Consumer Behavior, Utility Analysis, Law of Diminishing Marginal Utility, Law of Equi- Marginal Utility
2. 2. • Consumer Behavior • Utility Total Utility Marginal Utility • Utility Analysis Cardinal Utility Analysis Ordinal Utility Analysis • Law of Diminishing Marginal Utility Schedule and Curve of Law Relationship between Marginal Utility and Total Utility Assumptions of Law Exceptions of Law • Law of Equi-Marginal Utility Assumptions of Law Schedule and Curve of Law Limitations of Law remember you and I are here “to learn from each other” Contents….
3. 3. Consumer Behavior • Consumer Behavior is to achieve maximum level of satisfaction by spending his income. • Consumer wants to maximize its utility……
4. 4. Utility • Utility is want satisfying power of consumer. • Utility of good is a satisfaction or pleasure one gets from consuming it. Characteristics of Utility • Utility and usefulness are not synonyms. For example, painting of Picasso may be a great utility to art but is useless. • Utility is Subjective, utility of a product may vary widely from person to person. • Utility is difficult to quantify, But for the purpose of illustration it is assumed that utility can be measured with the units called “utils”. For example, a particular consumer may get 100 utils from coke, 50 utils from biscuits.
5. 5. Total Utility and Marginal Utility Total Utility: • Total amount of satisfaction a person derives from consuming some specific quantity of good or services. Marginal Utility: • Extra satisfaction a consumer receive from consuming additional unit of a product. • Marginal utility is change in total utility that results from consumption of one more unit of a product.
6. 6. Utility Analysis Cardinal Utility Analysis • Alfred Marshal • Utility can be measured in imaginary units that are called “Utils”. • Law of Diminishing Marginal Utility • Law of Equi-Marginal Utility Ordinal Utility Analysis • J.R. Hicks & R.G.D. Allen • Can not measured but compared as rank • Indifference curve
7. 7. Law of Diminishing Marginal Utility • Law of diminishing marginal utility states that, “as a consumer consume more and more units of specific commodity, utility from successive units goes on diminishing.”
8. 8. Law of Diminishing Marginal Utility 1 432 65 7 Units Total Utility Marginal Utility 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2 MU curve is downward sloping because of the fact that consumption of successive units gives less satisfaction. Negative MU
9. 9. Relationship between Marginal Utility and Total Utility Maximum TU Negative MU  TU is increasing, but it increases by smaller and smaller amount for each additional unit. In other words, TU is increasing at decreasing rate.  MU curve is downward sloping because of the fact that consumption of successive units gives less satisfaction.  Increasing TU Diminishing MU  Maximum TU Zero MU  Decreasing TU Negative MU Units Total Utility Marginal Utility 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2
10. 10. Assumption of Law • Various units of goods are homogenous. i.e. identical in size shape, quality, quantity etc. • The units of consumption are of reasonable size. The consumption is normal. • There is no time gap between consumption of different units. • Consumer is rational and he aims at maximum of satisfaction. • Taste, preferences and Fashion remains unchanged. • There must not be change in consumer behavior during consumption. A change in state of mind affects the validity of the law.
11. 11. Exception of Law • Case of intoxicants: Consumption of liquor defies the law for short run, the more a person drinks the more he likes it. • Application of money: More money the man has more greedy. • Rare collections. Collection of rare goods increase the marginal utility. Like collection of rare stamps and coins. • Reading: Reading of more books gives more knowledge and in turn greater satisfactions.
12. 12. Law of Equi-Marginal Utility • “Total utility from a given amount is maximum when it is spend on various goods in such a way that marginal utility of money spent on each good becomes equal”. • “Total utility of a given amount is maximum when it is spent on the principle of MUA/PA= MUB/PB=…………MUN/PN Where MUA is marginal utility of product A and PA represent price of product A. • “Other things remaining the same, consumer spend his income in such a way that the marginal utility of last unit of each an every commodity must be equal”.
13. 13. Law of Equi-Marginal Utility • This is called….. • law of satisfaction because we substitute more useful goods to less useful goods. • law of maximum satisfaction because through it we get maximum satisfaction. • law of equi-marginal utility because through it when the marginal utilities are equalized, through the process of substitution, the maximum satisfaction is attained.
14. 14. ASSUMPTIONS OF LAW • Rationality: Every consumer should be rational in the purchase of goods. His aim should be to maximize the total utility and nothing else. • Application of Diminishing Marginal Utility: Law of diminishing marginal utility is applicable on the commodities consumed by consumer. • Limited income: The income is given that consumer wants to spend on different goods at particular time. • Substitution of Goods: It is assumed that goods are naturally substitutes of each other. The result of substitution will be the MU of one commodity will fall and that of another commodity will rise. • Awareness of Market: It is assumed that consumer has much awareness about the market. • Divisibility of Goods: The law is based on the assumption that goods are divisible in small units.
15. 15. In the following example… • Consumer consume mango and apple • Consumer income is 10 Rs. • Price of mango and apple is 2 Rs.
16. 16. Law of Equi-Marginal Utility Schedule Units MU of Apple MU of Mango MUA/PA MUM/PM 1 20 18 10 9 2 18 16 9 8 3 16 14 8 7 4 14 12 7 6 5 12 10 6 5 TU 5 apple & 0 mango 40 TU 4 apple & 1 mango 43 TU 3 apple & 2 mango 44 TU 2 apple & 3 mango 43 TU 1 apple & 4 mango 40 TU 0 apple & 5 mango 35  Consumer maximize its total utility by consuming 3 units of apple and 2 units of mango. At this point his total utility is 44. TU=Maximum  Any point other then this will yield less total utility. MUA/PA = MUM/PM 8 = 8
17. 17. Units of MangoUnits of Apple MUM/PM MUA/PAConsumer maximize its total utility by consuming 3 units of apple and 2 units of mango. At this point his total utility is 44. Any point other then this will yield less total utility. For example, 2 units of apple and 3 units of mango gives total utility of 43, which is less then previous combination.
18. 18. Limitation of Law • No Cardinal Measurement: Utility is mental phenomenon and it is not possible to measure. So the equi-marginal utilities of commodities is not possible to measure. • Rationality: Consumer are not so rational about commodities of daily use and cannot calculate utility. • No Availability of Substitutes: Due to unavailability of substitutes for some commodities the equality of marginal utility is not possible. • Customs: Customs are generally so powerful that they make the consumption of a commodity compulsory. The operation of this law is impeded by custom. • Fashion: Sometimes a person follows a fashion against his wish. He thus spends money on an article which gives him less satisfaction and not on which would yield greater satisfaction. The law of equi marginal utility is disturbed in practice again. • Ignorance: If people do not know accurately the prices of various commodities, they cannot obtain maximum satisfaction out of their expenditure. They may purchase a commodity at a higher price when it is really available at a lower price. • Indivisibility: Some commodities are not divisible to the extent required for equalization of marginal utility.
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