What is Utility: Total utility & Marginal utility:

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Barnard Reynolds
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1 Economic Theory of Consumer Behavior * What is utility. * Define total utility and marginal utility.*** * State the law of diminishing marginal utility.**** * Define indifference curve and indifference map.*** * Write down the properties of Indifference curve.** * "Two indifference curves will never cut each other"- Explain the statement.***** * What is Marginal Rate of Substitution (MRS)? Give example.**** * What is Budget line. * How can we find consumer equilibrium point? Explain why this is the equilibrium point. or Explain the concept of consumers` equilibrium with indifference curve analysis. **** Production * What is production? Write down the factors of production. * What is production function? What are the features of production function? * Define Average revenue product and Marginal revenue product. * Returns to scale * What is Iso-quant? What are the properties of IQ? * Draw a Iso-cost line from the equation 200=2L+3K * Show the optimal combination of input where producers maximizes their profit.*** What is Utility: Utility means wants satisfying capacity. In ordinary language it means usefulness. In Economics the concept of utility is not associated with any ethical consideration. For instance, wine is harmful, but if it is demanded, it has utility. The air, sun, rain, rivers, etc. can satisfy human wants. So, they have utility. But their utility is not economic utility. The utility which we can get from our foods, shirts, books, etc., is economic utility; because the supply of all these things is limited in relation to their demand. Total utility & Marginal utility: Total utility is the sum of the utilities of all units of a commodity possessed by a consumer. Marginal utility is the utility of an additional unit of a commodity get by an individual. Quantity of good Consumed Total Utility Received (TU) Marginal Utility (MU) Total utility comes to ( =38) Hence, Marginal utility is the difference between the of (x+1) units and that of x units.

2 Utility/pric e Distinguish between total utility and marginal utility: 1. The total utility is the total satisfaction enjoyed from consuming any given commodity. On the other hand the extra satisfaction a person receives by consuming one extra unit of a good is called the marginal utility of that good. 2. When a person buys each extra unit, total utility increase but marginal utility decreases. 3. Total utility continues to increase as long as the marginal utility is above zero. 4. When marginal utility is zero then total utility is maximum. 5. If the person continues to buy after the marginal utility becomes zero then marginal utility will be negative and total utility will decrease. Law of diminishing marginal Utility Marginal utility refers to the change in satisfaction, or utility, resulting from consuming a little more or a little less of a commodity. In this example, To a thirsty man the desire for the first glass of sharbat may be very high and he may offer 10 TK but for the second glass he will not pay the same price. For the third glass he will offer still a smaller price. Let us explain the Law with the help of a schedule : Glasses of sharbat price offered 1 st glass 10 TK 2 nd glass 09 TK 3 rd glass 05 TK 4 th glass 02 TK So, gradually the person offers less and less prices as he gets more and more glasses of sharbat. It is because from successive glasses of sharbat he expects to get smaller and smaller amount of satisfaction. Y U P Q R O A B C D E numbers of Goods S G F U 1 X Above fig. Law of Diminishing Marginal Utility has been shown. Where OX-axis shows numbers of Goods and OY-axis shows Utility/price. UU 1 is Marginal Utility curve. * Define indifference curve and indifference map.*** Indifference curve. An indifference curve may be defined as a curve all the points show different combinations of two or more commodities where a consumer gets same utility from all the points.

3 Above fig. Indifference curve has been shown. Where OX-axis shows good 1 and OY-axis shows good 2. IC curve is Indifference curve where all the points show different combinations of two commodities and same utility. Indifference Map: A collection of indifference curves in a diagram. Write down the properties of Indifference curve.** 1. Indifference curve is downward sloping. 2. Two or more indifference curve cannot touch each other. 3. Above indifference curve is shown more utility from below indifference curve. * Two indifference curves will never cut each other"- Explain the statement. ***** Two indifference curves will never cut each other. Because above indifference curve is shown more utility from below indifference curve i,e IC1<IC2<IC3<IC4 What is Marginal Rate of Substitution (MRS)? Give example.**** Marginal rate of substitution (MRS) The slope of the indifference curve is called Marginal rate of substitution. Budget line consists of all bundles which cost exactly equal to the consumer s income. Budget line

4 Budget line Budget line consists of all bundles which cost exactly equal to the consumer s income.

5 What is production? Write down the factors of production. Production: Production is the process of using the service of labor and other resources to make goods and services available called outputs. Economic resources are the inputs in the process of production. They are divided into four broad categories. These are the factors of production. They are: 1. Land: 1. Land is the gift of nature; 2. Land is fixed in quantity. It has no supply price; 3. Land is permanent; 4. Land provides infinite variation of degrees of fertility and situation so that no two pieces of land are exactly alike. 2. Labor: 1. Labor is inseparable from the labor himself; 2. Labor has to sell his labor in person; 3. Labor does not last. It is perishable; 4. Labor has a very weak bargaining power; 5. There can be no rapid adjustment of the supply of labor to demand for it, because supply cannot be increased quickly, nor can be reduced. 3. Capital: 1. Capital is man made; 2. Capital perishable; 3. Capital is mobile; 4. The amount of capital can be increased. 4. Entrepreneur: 1. Initiate a business; 2. Taking final responsibility of the business enterprise; 3. Entrepreneur works as an investor. What is production function? What are the features of production function? The production function is a mathematical expression describing the relationship between the quantity of the particular product and the quantities of particular inputs used. Thus the kind and amount of product is the function of kind and quantities of input used.

6 The simple form of production function would describe the relationship between one product and one variable resource. Thus the production function Y = f (X) tells the decision-makers how the amount of output Y depends upon the amount of inputs X used. But it should be noted that a product is never a function of a single factor. In mathematical symbols: Quantity = f Technology (Land, Labor, Capital) We sometimes represent the relationship between inputs and output with a production function, like so: q = f(k,l). This is a mathematical representation that tells how much output (q) you ll get from any combination of inputs (K and L). A production function can be very complex, but here s a simple example: q = K L. Define Average revenue product and Marginal revenue product. Total, Average and Marginal product Total product: The total amount of output produced, in physical units or numbers. Average product: The total output divided by total input, or output per worker. Marginal Product: It is the extra or additional product/ output added by one extra unit of an input (say, labor) while other inputs are fixed/constant. Units of labor Total product Marginal product Average product ,000 2,000 2, ,000 1,000 1, , , , , The table shows the total, marginal and average product that can be produced for different inputs of labor when other inputs (capital, land etc.) and state of technical knowledge are unchanged. The law of diminishing marginal returns It holds that we will get less extra output when we add additional units of an input, say labor, or capital, while holding other inputs fixed. In other words, the marginal product of each unit of input will decline as the amount of that input increases, holding other things constant. An example will be from the Agriculture sector. The law of diminishing Marginal Returns: A short run phenomenon The short run is a small time period in which it is not possible for a firm to change all the inputs in response to the changes in the market situation. The firm can, at best, change one input leaving other constant. In the short run, it can adjust production activities by changing variable factors like materials and labor but cannot

7 change fixed factors such as capital. Now, in this situation the firm experiences law of diminishing marginal returns. So we can say that law of diminishing marginal returns is a short run phenomenon. Returns to scale a) Constant returns to scale: When all inputs are increased by, say, three times, the output also increases by three times, it are called constant returns to scale. An example will be from a typical firm in the handicraft/small industry. b) Increasing returns to scale: When all inputs are increased by, say, two times, the output increases by more than two times, it is called increasing returns to scale. An example will be from a typical firm in the manufacturing industry. c) Decreasing returns to scale: When all inputs are increased by, say, three times, the output increases by less than three times, it is called decreasing returns to scale. An example will be a from typical firm in the agricultural industry. Marginal product Change in output per unit of change in the input when all other inputs are held constant. Marginal revenue Change in total revenue per unit change in sale of output. Marginal revenue product (MRP) of a factor Marginal Revenue times Marginal Product of the factor. Iso-quant Iso-quant may be defined as a curve all the points show different combinations of two or more input where a producer gets same production from all the points. capital Labour Above fig. Iso-quant has been shown. Where OX-axis shows labour and OY-axis shows capital. IQ curve is Iso-quant curve where all the points show different combinations of two inputs and same production. Write down the properties of Indifference curve.** Iso-quant curve is downward sloping. Two or more Iso-quant curve cannot touch each other. Above Iso-quant curve is shown more production from below Iso-quant curve.

8 Capital C g~jab Iso-cost line Iso-cost line consists of all inputs which cost exactly equal to the consumer s cost. M C = 100 K2 A K1 0 L1 L2 B Draw a Iso-cost line from the equation 200=2L+3K Marginal rate of Technical substitution (MRTS). Labour The slope of the Iso-quant curve is called Marginal rate of Technical substitution. Determination of least-cost Combination ( see: class note)

9 Labour

Chapter 21. Consumer Choice

Chapter 21. Consumer Choice Consumer Choice Utility is most closely defined as a) extra. b) marginal. c) usefulness. d) satisfaction. e) opportunity cost. Copyright Houghton Mifflin Company. All rights reserved. 21 2 Utility is most