managerial economic sip art

8/9/2019 Managerial Economic Sip Art

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What is Economics ?



Economics is the science of choice in the face of unlimited ends and scarce resources that have

alternative uses.

Since resources are scarce and the uses to which

they can be put to are unlimited, one is requiredto choose the best amongst the availablealternatives.



Several thinkers have given differentdefinitions of economics.

According to Alfred Marshall, economics isthe study of mans actions in the ordinarybusiness of life, it enquires as to how hegets his income and how he utilises it.

Thus on the one hand it is the study of wealth, on the other it is the study of man.



According to Lionel Robbins, economicsstudies human behaviour as a relationship

between unlimited ends and scarcemeans, which have alternative uses.

Thus, Robbins says that, economics canhelp a man to choose how to make use of his scarce means for the maximum

satisfaction of his unlimited ends.



It was J.M.Keynes who pointed out thateconomics also dealt with issues

concerning the nation as a whole.

Keynes defined economics as the studyof administration of scarce resourcesand of the determinants of

employment, income and growth.



micro-economics studies the behavior of anindividual decision-making economic unit like a

firm, a consumer, or an individual supplier of some factor of production

In simple terms, managerial economics isapplied micro-economics. It is an application of that part of micro-economics, which is directlyrelated to decision making by a manager.



True or False

According to Marshall, economicsis primarily concerned with the

study of wealth.



True or False

The modern view hold economics asbeing composed of price, income,

employment and growth theories



Economic analysis attempts to explain the working of

economic systems. Assume a simple economic system consisting of two

sectors, whose activities are systematically connectedwith one another. The economic activities performed

by economic agents are generally classified into threeinter-related activities:

a) Supplying factor inputs, like land, labour, capital,organisation and enterprise, which enable the agentsto earn incomes which in turn could be used for purchasing consumable goods;

Circular Flow of Economic Activities



(b) Using the factor inputs (raw materials,machines, labour, land, etc.) for producing

goods to be supplied to the consumers; and

(c) Providing intangible and specialized

services directly to the people (example,lawyers, teachers, doctors, and porters) or working for the government (example, soldiers, judges, policemen, etc.).



The nature and dimensions of economicactivities are generally determined by the extent

of overall economic development.

For instance, a developed economic system

like that of the United States or Japan, hasmore specialized activities and division of labour, as compared to a traditional economicsystem



Forms of Organisation

In modern times, organisation of business assumeseveral forms, viz., sole proprietorship, individual

entrepreneur or one-man business, partnership, joint±stock companies, industrial combination, co-operativeenterprises and State enterprises.

a) Individual Entrepreneur: Under the µone-man¶concern, organiser invests his/her own capital andmay also borrow some.

He/she rents a shop and employs a worker, if necessary. He/she personally make purchases and

attends to the sales, and is also the owner manager,who also takes the entire risks. Thus, an entrepreneur organizes, directs all economic

activity and takes the full risks, and is the soleproprietor.



b)Partnership: In partnership firm, two,three or more people join together,

contribute capital, and share the profitsand risks of losses in agreed proportions.

c) Joint-stock company: It is the mostimportant type of business organisationtoday. It overcomes the disadvantages of

the artnership arising out of smallfinancial resources and limited businesstalent.



Co-operative enterprise:

They are of two types ±

1) producer¶s cooperation, and 2) consumer¶s cooperation.

i) Producers cooperation: Under it, the workers take

up the entrepreneurial work, They contribute somecapital and borrow the rest; elect their own foremanand managers and employ other staff. After allexpenses on rent, capital, salaries and wages, theprofits are divided by the workers.

This type of co-operation is called the productive co-operation or producer¶s co-operation.



ii) Consumer¶s cooperation: Under it, theconsumers of a region contribute small

shares of capital and start a store. Theseco-operative stores buy goods fromwholesalers or, and sells them to themembers at the market price.

The profits are shared by the members inproportion to their purchases or,commonly, in proportion to their capitalshare. Usually, the capital share iscontributed equally and therefore profits

are, also equally shared by the members.



State enterprise: The organisation of stateenterprise is similar to that of the private

enterprises with consisting of general manager,foremen, works manager, accountants,treasurer, departmental heads, etc.

Its working is generally similar to that of a joint-stock company. But, the fundamental differenceis that all its employees are government

servants with fixed tenure and pension benefitson retirement. The capital comes from the staterevenue, which are attributed by the tax-payers.

Therefore, the profits, if any, go to the state.



Public enterprises: Public enterprises may bein the form of

i) Departments, i.e., run by a governmentdepartment, e.g., railways and posts andtelegraph in India,

ii) Corporation, e.g., Life Insurance Corporationof India established by a special Act of Parliament, and

iii) Limited Liability Company registered under the Companies Act.



3. Scope.

(a) Microeconomics ± the study of individualeconomic behavior where resources are costly,e.g., how consumers respond to changes inprices and income, how businesses decide onemployment and sales, voters¶ behavior andsetting of tax policy.

(b) Macroeconomics ± the study of aggregateeconomic variables directly (as opposed to theaggregation of individual consumers and

businesses), e.g., issues relating to interest andexchange rates, inflation, unemployment, import

and export policies



Concept of Slope The concept of slope is important in economics

because it is used to measure the rate at whichchanges are taking place. Economists often lookat how things change and about how one itemchanges in response to a change in another item.

It may show for example how demand changeswhen price changes or how consumptionchanges when income changes or how quicklysales are growing.

Slope measures the rate of change in thedependent variable as the independent variablechanges. The greater the slope the steeper theline.



Profit Maximisation

A majority of the organisations regard profitmaximisation as the sole criteria for their existence.

The primary motivation of such organisation is toincrease profits«ex (colgate, Britannia) (Titan)

Maximising profits involves maximising revenueswhile simultaneously minimising costs.



Thus, any managerial decision which is able toincrease revenue without a proportionate rise

in costs or can reduce costs without a fall inrevenue, will increase profits.

Profit maximisation in its most lucid connotationmeans the generation of the largest absoluteamount of profits over the time period beinganalysed ± short ± or long-run While short runis the period where at least one factor of production is constant, in the long-run all the

factors are variable.



A company ability to control its costs variesdepending on the time it has to react. As thetime increases, the proportion of variable costsalso increases.

In the short-run some costs are fixed but in the

long run , all costs are variable. The companymust recover all its fixed costs whether or not itproduces any output.

It should continue producing the output , if it cansell it at a price that covers the additionalvariable cost that it will have to incur for

production.



A printing operator operating one printing presson a one year lease. He employs three workers

on a one-day contract.

While the one year lease rental for the press is

Rs.50,000. Each worker must be paid Rs.80per day. The cost of paper, ink, electricity andother miscellaneous expenses for printing onebook is Rs.100. On any given day, besides the

cost of the press, the cost of the workers is alsofixed since they have already been employed.



For the following day, the cost of the press remains fixedbut the wage cost of the workers is variable, as theone-day contract can be allowed to lapse.

Similarly for the following year, all the costs of the printer become variable since then the printer has the optionof not renewing the lease on the press and notemploying any worker either.

Now, suppose the printer receives an order in the short ±run , for printing books worth Rs.400. This will besufficient to cover costs of the worker the raw materialand miscellaneous expenses and also contributeRs.60 to the fixed overheads, which have to be paidregardless of the order.



In this case, the printer should accept the order.

If however, the worth of a day¶s job is less than that of Rs.340, then the printer should not take up the order,since he will be better off not hiring any worker or spending on raw material and other expenses andletting his press remain idle.

In the long-run , in this case in a year, all the printerscosts are variable.

Therefore, he should get out of the business unless heexpects to generate enough revenue to cover thecosts of the printing press, workers, raw material,other expenses and the capital involved in thebusiness



In the short-run , a firm can only producemore output by working on its fixed factor harder.

In our example, if the printer were to receivea huge order to be completed the next

day, there would not be enough time toincrease the number of presses.

The only way to meet the new demandwould be by increasing the number of workers.

In the long-run, however, the firm can alter

both- the fixed factor and technology.



A firms choice of technology will determine thecost of production for different levels of output.

Besides, achieving the lowest unit cost for anygiven level of production, the other aim of profitmaximization is to earn the highest possible

revenues.

The extent of profits for a given level of costsdepend upon the revenues that a firm can

achieve, which in turn is a function of theconsumers willingness to pay for a particular product.



How much a consumer is willing to pay willdepend on his income, tastes and also on the

price of related goods.

The maximum price that a consumer is willing to

pay for one more unit of a particular good isknown as the reservation price.

A firm must price its product in such a way thatthe nth ranked consumer pays just thisreservation price for the nth unit of the output.



Given a choice, any firm would want to charge thereservation price from every consumer. But thisseems unlikely because it can usually charge

only a single price for all the output it sells.

Thus in order to sell to the nth consumer , it mustsell to the n-1 consumers at a price below what

they will actually be willing to pay.

In other words, if a firm lowers its price to expandits market by one additional consumer, it loses

the value of price reduction to the last customer.

The net of these two values is known as themarginal revenue.



It represents the change in total revenuedue to the sale of one additional unit.

While each additional unit brings inadditional revenue, it also increases thefirm¶s cost. This increase in the total costdue to the sale of one additional unit isknown as marginal cost.



Marginal revenue is the increase inrevenue from selling one more unit of a

product. It differs from the price of theproduct because it takes into account theeffect of changes in price.

For example if you can sell 10 units atRs.20 each or 11 units at Rs.19 each, thenyour marginal revenue from the eleventhunit is (10 × 20) - (11 × 19) = Rs.9.



The concept is important in microeconomicsbecause a firm's optimal output (mostprofitable) is where its marginal revenueequals its marginal cost: i.e. as long as theextra revenue from selling one more unit is

greater than the extra cost of making it, itis profitable to do so.



Ideally, the firm must choose a price-outputcombination that yields the highest revenue at

lowest cost, for maximising profits.

As long as the marginal revenue exceeds the

marginal cost, it will be worthwhile to add thatextra customer as then the overall profit willincrease.

Once the marginal cost equals the marginalrevenue, the last consumer makes no additionalcontribution to the profits of the firm.



Basic concepts of economics

The three most vital concepts are ± opportunitycost, marginal analysis and discounting.



OPPORTUNITY COST

Opportunity cost of a decision is the cost of

sacrificing the alternatives to that decision.

The question of sacrificing arises because of the

fundamental economic problem of scarceresources which forces the manager to choosethe best out of the available alternatives.

Choosing the best automatically means leavingbehind all the remaining alternatives.



Opportunity cost confronts us at every point inlife. But, most of the times, we don¶t take this

cost into account when making decisions.

For example, a shoemaker making chappalsinstead of shoes and sandals.

Even when a person decides to invest his moneyin the debenture of a company, he comparesthe returns on his investment with what hecould have earned if this money was kept in abank as fixed deposit.



Marginal Analysis

Economists look at how costs and benefits change as there are

small changes in actions. We call this marginal analysis, and it is perhaps the key concept in economic analysis.

Marginal Analysis is concerned with finding out the change inthe total arising because of one additional unit.

In any case, be it a firm deciding whether or not to expandproduction, a student deciding if another beer is a good idea, or a professor choosing to give an extra exam, optimalperformance requires that benefits and costs be equilibrated onthe margin.

What this means is that if the additional benefit exceeds theadditional cost, take the action. Keep taking it as long as thebenefit exceeds the cost, and to ensure that all excess benefits(those that exceed costs) are accrued, do it until for the last

action, the benefits just equal the costs.

Th b fi f h l i ( h i



The benefits from the last action (such as unitof production or consumption) are termedmarginal revenue, and the costs from that

action are termed marginal costs

In 1990, the National Aeronautics and Space Administration (NASA) launched into orbit the

Hubble Space Telescope, a new orbiting telescope that by being in space avoided atmospheric distortions from astronomical observations. Astronomers expected vast new

gains and insights in their scientific explorations.

U f t t l f d Whil b i



Unfortunately, someone goofed. While beingtested after being in orbit, scientists andengineers at NASA discovered some flaws in

the mirrors used in the telescope thatsignificantly diminished the ability of thetelescope to gather signals from deep space.The scientists were devastated, butimmediately set upon ways to rectify theproblem. Of course the solution was costly.

Politicians were outraged, some calling the

Hubble Space Telescope a $2 billion debacle.There was a strong movement to deny anymore funds to the project, since NASA had notgotten it right initially. But marginal analysisreveals a much different perspective.



The $2 billion or so dollars already spent on the HubbleTelescope did not matter. What was relevant at thatpoint was what were the gains and losses from fixing

the problem or leaving the telescope as it was.

In its flawed state, the Hubble Telescope could still

perform many useful and interesting scientificfunctions. Corrected, it could perform more.

The only relevant question at that point was whether or

not the additional scientific discoveries that wouldcome from fixing the problems would be worth the costof the repairs. The initial expenditure to build andlaunch the Hubble Space Telescope did not matter

anymore.



Total revenue is the total money received fromthe sale of any given quantity of output.The total revenue is calculated by taking the

price of the sale times the quantity sold, i.e.total revenue = price X quantity.



Revenue is the income generated from theoutput produced by firms and then sold in

goods markets. It is also known as salesturnover.

The revenue the firm can create depends onthe strength of demand for the products theyare supplying - in other words how much outputcan be sold at a given price.

TOTAL REVENUE = Price per unit x Quantitysold ( TR = p x q)



AVERAGE REVENUE = Total revenuedivided by output

MARGINAL REVENUE = the change intotal revenue as a result of selling oneextra unit of output.



Discounting Principle

Almost all managerial decisions relate to thefuture. The value of money today is not thesame as it will be at a later point of time.

Anything that is received later alwaysinvolves an element of risk.

A rupee received today is more valuablethan a rupee that will be received later.This is known as the time value of money.



Suppose a person is offered a choice to makebetween a gift of Rs.100/- today or a Rs.100

next year. Naturally, he will choose Rs.100today. This is true for two reasons :-

- The future is uncertain and there may be

uncertainty in getting Rs.100/- if the opportunityis not availed of

- Even if he is sure to receive the gift in future,today¶s Rs.100 can be invested, so as to earninterest say as 8%, so one year after it willbecome RS.108



Demand and Supply

Economics studies how society allocates thelimited resources of the earth to theinsatiable appetites of humans.

Supply and demand are the forces at work. At what is referred to as the equilibrium(E), the market price allows the quantitysupplied to equal the quantity demanded.

Suppliers are willing to sell, and consumersare willing to buy. Supply equals demandfor a price.

f



That in a nutshell, is the basis of all economictheory.

For example, lets take a look at the local pub,Porth Tavern which brews its own beer, spudbeer. Imagine you are a fosters drinker and thebar is running a 25 cents special discount onmugs of Spud beer.

The owner has ten kegs on hand, but feels if hewere to charge the usual dollor per mug, hemight be able to sell one or two kegs.

Y lik F t b t t 25 t d id t t



You like Fosters, but at 25 cents you decide to trythe cheaper brew. Here, in this bar, the³invisible hand´ of economics is at work. At the³right´ price, there is a demand for the ten kegs.

supply

demand

Mug price

.25

cents

0 2 4 6 8 10 14 16 18 20

Th h h th t th i



The graph shows that as the price per mugincreases, the brewery would be willing toproduce more , but people would be less willingto buy.

Generalising from this simple relationship to anentire economy, aggregate supply ( AS) equalsaggregate demand ( AD) at an equilibrium priceand level of economic output. The graph is

similar to beet graph, the same relationshipholds, but the elements measured constitute amuch more serious MBA subject.



AS

AD

Price Level

(P)P

0 2 4 6 8 10 14 16 18 20Economic Output (Y)

Level of Economics : MICRO OR MACRO



Level of Economics : MICRO OR MACRO

Micro economics deals with the supply and

demand equation of individuals, families,companies, or industries. The Fosters versusSpud beer competition was an example of Micro-economic battle.

Macro-economics , on the other hand, concernsitself with the economies of cities, countries or the world as shown in the second graph. Simply

put, ³micro´ economics deals with ³small´,specific situations; ³macro´ economics loos atthe ³big´ picture of entire economies.

Mi E i



Micro Economics

Micro-economics is less glamorous thanmacro-economics, but it is a little morepractical.

Since most of us are not likely to have a

macro-effect on a whole economy , we willconcentrate on a few basic concepts thatmake-up micro-economic knowledge.



Opportunity Costs - Revision

Because our appetite for goods and servicesare insatiable, decisions have to be madeto determine how to allocate limitedresources.

Most often, the increase in production of agood or service requires that a cost or

sacrifice be incurred. Economists callthese costs opportunity costs.

For example in 1992 the demand for Harley



For example, in 1992 the demand for Harley-Davidson motorcycles had the company¶sfactories operating at 100 % of capacity.

Harley controlled 60% of the big-ticket, big-bikemarket, and management was forces to decidehow best to allocate limited production capacity

to satisfy demand.They chose to produce several models for sale inthe United States and abroad.

As a result, Harley Davidson, incurred a

significant opportunity costs because thecompany decided not to devote its entirecapacity to its most expensive and profitablemodels for export to Japan.



Had Harley tried to maximise short term profits,it would have risked alienating the domestic

market of devoted bikers ± the very groupthat helped create the Harley mystique thatthe Japanese are buying.

Opportunity cost, therefore, is the cost of choice, when output, time and money arelimited.



Marginal Revenue and Cost - revision

A concept closely associated with opportunitycost is marginal revenue and marginal cost.

Companies are motivated to maximise total

profits by maximising revenues and minimisingcosts. If a business has the opportunity to selleven a single additional unit at a profit, it should

produce it. The Marginal Revenue (MR) fromsale should exceed the marginal cost (MC) toproduce.

Enterprises should continue to produce until their



Enterprises should continue to produce until their MR=MC. At that point of equilibrium themarginal profit on the next unit sold will equalzero.

No profits are left on the table. Past that level, themarginal revenue of each additional unit solddecreases and the marginal cost increases.

Experience tells us that more units businesses tryto push on the market, the less the market iswilling to pay for these goods.

The cost of producing one additional unit is



The cost of producing one additional unit isminimal. But if there is no excess capacity anda company wants to produce more units, new

workers will need to be hired, new equipmentpurchased and a larger factory leased or built.

Therefore, once a factory reaches capacity , themarginal cost of producing one additional unitincreases beyond the cost of last unit produced.

In the case of a cattle rancher, ram singh, themarginal cost of adding a sheep to the herd isminimal. Fences still have to be mended andthe pasture maintained.

Since he is a rational decision market Ram Singh



Since he is a rational decision market, Ram Singhwill add cattle to the point that the marginalrevenue from the same of an additional sheepwill cover these marginal costs of raising thissheep. (MR=MC).

If the cost of raising one additional unit becomeshigher than the current market price, then RamSingh will stop adding sheep to his herd.

Why the demand curve is flat rather than



Why the demand curve is flat rather thandownward sloping, as in the case of other demand curves. It is because the price of meat

is determined in a competitive auction.

The few additional head of cattle that Ram Singh

might bring to the market will not affect the pricethat is determined by the output of thousands of ranchers and meat processors.

But if Ram Singh had a corner on the meatmarket , or a monopoly then presumably hewould always produce and sell at the pointwhere MR=MC.



The marginal cost and revenue concepts would

also hold true for a cookie factory manager faced with a large special order.

Imagine yourself in his apron. The customer wants to pay 1.00 Rs. Per dozen for 100dozens to be sold at the local mela. You havesome excess capacity and so you go to your

A t t d k h t t i t



Accountant and ask what your cost is tosatisfy this order. She asserts that it wouldcost Rs.1.45 per dozen. She gives you thisbreakdown as proof.

Cookie Batter Rs.0.80

Labor Rs.0.25Factory utilities Rs.0.20

Factory upkeep Rs. 0.20

----------Total cost Rs.1.45

From that information you can see that the only



From that information you can see that the onlymarginal cost of running the automated cookieproduction line is the extra batter.

The machine operator would be there anyway,and the large oven would be on anyhow. Thefactory would continue to require the usualmaintenance.

The factory manager would welcome the order because he can make a marginal profit.

As shown in the sheep and cookies examples



As shown in the sheep and cookies examples,³marginal´ costs and revenues are critical inmaking ³marginal´ pricing and productiondecisions.

However, to evaluate profitability of an entirebusiness , rather than one transaction , totalrevenue must exceed total costs to make abottom line company profit.

Before we analyse demand in order to forecast



Before, we analyse demand in order to forecastit, it is very important to understand the basis of consumer demand i.e why , when and howmuch does the consumer purchase.

Utility i.e the want satisfying quality of a good or service, is the prime factor that generatesdemand.

Utility is the terms used to describe the value of

a product to a consumer.

Marginal Utility (MU) means the usefulness or



Marginal Utility (MU) means the usefulness or utility of having an additional unit of a product. At some point a buyer is fully satisfied, and anadditional unit is of no value.

Going back to the beer example, suppose youare looking to forget whatever troubles youhave and you order one more beer at PortTavern. A second beer would be welcome and

infact would be of great Marginal utility. Fivehours later you have had twelve beers, playedbowling, danced and in the process forgottenyour troubles.



At his point, an extra beer would be of littlevalue.

THE MARGINAL UTILITY OF THETHIRTEENTH BEER IS NEGLIGIBLE.

C t f d d



Concept of demandDemand for a commodity implies

Desire to acquire it Willingness to pay for it

Ability to pay for it

Mere desire to buy a product is notdemand. A miser¶s desire for this ability to

pay for a car is not demand because hedoes not have the willingness to pay for it.

Similarly a poor man¶s desire for and his



Similarly a poor man s desire for and hiswillingness to pay for a car is not demandbecause he lacks the necessary purchasingpower.

One can also conceive of a person whopossesses both the will and purchasing power

to pay for a commodity, yet this is not demandfor that commodity if he does not have desire tohave that commodity.

Demand for a commodity refers to the quantity of the commodity which an individual household iswilling to purchase per unit of time at aparticular price/

Types of demand



Types of demand

Direct and indirect demand

Demand for goods that are directly used for consumption by the ultimate consumer isknown as direct demand. Demand for allconsumer¶s goods such as bread, tea,readymade shirts, scooters, houses is directdemand.

Indirect demand is the demand for goods that arenot used by consumer¶s directly. They are usedby producers for producing other goods.

Examples of indirect demand are demands for



Examples of indirect demand are demands for machines, tools, coal and any raw material.

While direct demand depends primarily upon theconsumer¶s income, indirect demand dependsupon the concerned producer¶s output.

In the above example, if cloth is a consumer good, then its demand will depend on the

consumer¶s income, while if it is used by agarment manufacturer, then its demand woulddepend for readymade shirts and trousers.

Derived and autonomous demand



Derived and autonomous demand

The goods whose demand is not tied with thedemand for some other goods are said to have

autonomous demand, while the rest havederived demand.

Thus, while demand for tyres is derived since itdepends upon the demand for vehicles, thedemand for milk or vegetables is autonomous.

However, since almost all products depend onothers to some extent, the difference betweenthe two is of more degree.

Durable and Non-durable goods demand



u ab e a d o du ab e goods de a d

Durable goods are those that can be used morethan once, over a period of time, as againstnon-durable goods that can be used only once.Both producer and consumer goods can be

durable and non-durable.

Durable goods are used while non-durable goodsare consumed. Amoung producer¶s goods while

machines, tools, etc are non-durable.Consumer¶s goods such as bread, jam etc arenon-durable while car, readymade garmentsare durable.

Firm and Industry Demand



Firm and Industry Demand

As the name indicates, firm demand is thedemand for the product of a particular firm. Onthe other hand , demand for the product of aparticular industry is known as industrydemand.

For example. Demand for pens is an industry

demand, while the demand for Parker pens is afirm demand. Similarly, demand for Colgatetoothpaste and toothpaste in general are firm

and industry demands respectively.

Total Market and Market Segment Demand.



Total Market and Market Segment Demand.

Demand analysis requires not only the totaldemand for a product but also a break-up of thedemand for the product in different parts of themarket.

The market may be segmented on the basis of age, geographical region etc. Thus while the

demand for kwality ice cream in India is TotalMarket Demand, demand for Kwality ice creamin Rajasthan or demand for Kwality ice cream

by women is a market segment demand

Utility Analysis



Utility Analysis

The Utility analysis was developed by AlfredMarshall to explain consumer demand. Thisapproach was based on the fact that utility isquantifiable i.e it can be measured in someunits. The unit for measurement of utility isknown as util.

Thus for example, it can be said that ice creamhas 10 utils while Rasgulla has 6 utils. Thisholds true for a person who likes ice cream

more than rasgulla.

Since utility can be measured in specific units ,



Since utility can be measured in specific units ,so it can also be added. We thus have totalutility and marginal utility.

Total utility , which is a measure of the overallsatisfaction, is defined as the total satisfactionderived from the consumption of all the units of a good or service.

Marginal utility, on the other hand is the changein total utility when one additional unit of a goodor service is consumed. Thus, if the utility

derived from the consumption of 1,2,3«.n..

Units of goods or services are U1, U2, U3«.Un



Units of goods or services are U1, U2, U3«.Un

then

Total Utility for 1 unit TU1 = U1

for 2 units TU2 = U1 + U2

for 3 units TU3 = U1 + U2 +U3

for µn¶ units TUn = U1+U2 +U3 +..Un

Marginal utility for the 2nd unit MU2 = TU2 ± TU1

for the 3rd unit MU3 = TU3-TU2

Assumptions of Utility Analysis



p y y

1. Utility is cardinal (fundamental)

2. Utility being quantifiable is additive3. Various units of a commodity consumed are

homogenous. For example, if the case relates

to the consumption of 200ml bottles of softdrink , then all the units consumed must be200ml bottles of the same soft drink

4. There is no time gap between the

consumption of successive units. Theconsumer goes on consuming the units oneby one, without any break

5. The consumer is rational, i.e he has perfect



, pknowledge and maximises utility.

6. The consumers income is limited andconstant

7. The tastes and preferences of the consumer remain unchanged

8. The marginal utility of money is constant.Here the marginal utility of money is thechange in total utility that results from

spending one additional unit of money.

managerial economic sip art

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