In the present-day sense, Economics is a subject whose study helps individuals, groups, nations and

even international organizations make important choices for material welfare, both short-term and
long-term, under limitations or constraints of resources. Under its widespread umbrella comes the
individual or the household going to the market, the firm trying to make profits, the village growing
into an industrial town, the less developed country striving for development, multinational
organizations and the world economy in general.

Marshall’s Principles of Economics (1890), the pioneering work of Neo-Classical tradition, provided
the following definition of Economics: "a study of mankind in the ordinary business of life; it
(Economics) examines that part of individual and social action which is most closely connected with
the attainment and with the use of the material requisites of wellbeing. Thus it is on one side a study
of wealth; and on the other, and more important side, a part of the study of man."

Robbins’s Definition In 1932, in Lionel Robbins’ Essay on the Nature and Significance of Economic
Science, Lionel Robbins highlighted another aspect of the subject, choice under conditions of
scarcity. "Economics is a science which studies human behavior as a relationship between ends and
scarce means which have alternative uses."

First, resources or means of production (land, labour, capital goods such as machinery, technical
knowledge) are scarce or limited. Secondly, what is applied to the production of a certain commodity
or service is unavailable for the production of another, alternative one. But human wants for the
consumption or use of goods and services (food, clothing, housing, education, entertainment) are
countless and unlimited. So people or organizations must chose among them. Economics is the study
of how people (or organizations) can choose to use the scarce or limited resources to produce
various good and services and distribute them to various members of society for them to consume.
Contemporary Economics is largely built upon this Robbinsian understanding of Economics.

If we look at the above two equally famous definitions, we see that while Marshall regards it as a
`study of mankind’, which is what Humanities is, Robbins sees it as a Science.

Indeed the scope of Economics is so wide that it is difficult to label it as either science or art. It is
perhaps a mixture of both. As Nobel Prize winner Paul Samuelson put it, “Not only is Economics at
once art and a science, economics as a subject can combine the attractive features of both the
humanities and the sciences”

But even if the epithet `science’ is given to Economics, it remains a Social Science. It is, to use
Marshall’s words, `the study of mankind’, of people as members of a society or nation or economy,
acting and interacting among themselves in the complex process of production and exchange,
consumption and distribution.
3.2.3 Economic Laws “economic laws are statements of economic tendencies are those social laws
which relate to braches of conduct in which strength of the motive chiefly concerned can be
measured by money price”.

Earlier economists often used the term `law’ to describe their conclusions/theories, e.g., The Law of
Demand, the Law of Diminishing Marginal Utility, the Law of Diminishing Returns. These are not laws
in the sense of being inexorable, enforceable or universal laws, but merely general trends or
tendencies arrived at by Deductive or Inductive methods as the case may be. For example, the Law of
Demand states that, all else being equal, as the price of a product increases, quantity demanded
falls; likewise, as the price of a product decreases, quantity demanded increases.

In other words, quantity demanded and the price are inversely related, other things remaining
constant. If the income of the consumer, prices of the related goods, and preferences of the
consumer remain unchanged, then the change in quantity of good demanded by the consumer will
be negatively correlated to the change in the price of the good.. However, there are exceptions to
this rule and in modern textbooks this proposition is not presented as a law..

Again, the law of Diminishing Marginal Utility states that as a person increases consumption of a
commodity while keeping that of others constant, there is a decline in the marginal utility that
person derives from consuming each additional unit of that product. This, in the Neo-Classical
analysis of Alfred Marshall, was the basis of the Law of Demand. Subsequent analysis has shown that
the inverse relationship between quantity demanded and practice can be derived without reference
to any such `law’ of Diminishing Marginal Utility.

3.1 What is Utility?

“Utility,” in plain English, means usefulness. Economists define utility as the benefits consumers
obtain from the goods and services they consume. However, people may have different views on
what is more useful and what is not. Moreover the price we are willing to pay is not always linked to
how useful a good is. For instance, a person may be ready to pay a lot more for a BMW than for a
Hyundai car, which may well be just as useful. Also there are many questions we need to answer like
- how are we supposed to quantify the “amount” of utility/benefits associated with different
choices? Is one person’s utility/benefit comparable to that of another’s? How do the benefits derived
from consumption of different quantities of the same good differ? To answer some of these
questions, it becomes important to measure these benefits or derive a measure of utility. Economists
have discussed various ways to use the indicator of utility to measure benefit derived by a person
from consumption. Some have given a monetary measure, while others proposed ranking the
benefits. Over time economists have identified that all that matters about utility as far as consumer’s
choice behavior is concerned is whether one consumption bundle has a higher utility than another
consumption bundle. In other words, preferences of a consumer determine their choices and utility
is a way of describing preferences.

3.3.1 Diminishing Marginal Utility We see the marginal utility is derived from total utility clearly
from the example in Table 2. As consumption of x increase, total utility increases, but at a decreasing
rate i.e. the addition to utility is reducing as we consume additional units of x and hence marginal
utility declines as consumption of x increases. This is because as we consume more, the good
becomes less desirable with subsequent units giving lesser satisfaction at the margin than the
previous unit consumed. This is called diminishing marginal utility.
Another very basic example is water. Suppose you are extremely thirsty after returning home on a
hot summer afternoon. The first glass of water you drink gives you immense satisfaction as it
quenches your thirst. The second glass also gives you satisfaction with its cooling effect, but it is less
valued than the first glass. Subsequently the third and fourth glasses of water give even less
satisfaction or utility as your thirst is already quenched. This demonstrates that the marginal utility
derived from consuming water will diminish. The above phenomenon is called the Law of
Diminishing Marginal Utility3 .

The law of diminishing marginal utility states that “the extra benefit or utility that a person derives
with increase in consumption of goods , diminishes with each additional unit of the goods consumed.

3.3.2 An Application: The diamond/water paradox The paradox in Adam Smith’s4 words “The things
which have the greatest value in use have frequently little or no value in exchange; and, on the
contrary, those which have the greatest value in exchange have frequently little or no value in use.
Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in
exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of
other goods may frequently be had in exchange for it.” Using the concept of marginal utility, the
solution to the paradox is simple. The maximum amount a consumer is willing to pay for a given unit
of a good depends on the marginal utility he derives from it; i.e., from the example in Table 2 above,
the consumer will be willing to pay the most for the 1st unit of ice cream consumed and he’d be
willing to pay less for additional units consumed thereafter. Essentially, if diminishing marginal utility
holds, then as a consumer purchases more of a good, the less is the marginal utility and hence he will
be willing to pay less for each extra (marginal) unit. Also willingness to pay depends, ceteris paribus,
on the level of consumption, since the greater the amount consumed, lower is marginal utility. In
case of water (w), it is so plentiful and relatively cheap that we use so much of it and hence the utility
derived from the final unit consumed is quite small. Whereas diamonds (d) are scarce in relation to
demand and because we use them in small quantities (as compared to water) the utility derived from
the last unit and its price are very high. The total utility of all the water used by a consumer is far
greater than the total utility from all the diamonds she buys. However, demand depends on marginal
utility and not on total utility. 3 The law was developed by Alfred Marshall 4 Adam Smith, Wealth of
Nations, Book 1, Chapter 4 The Law of Diminishing Marginal Utility states that “the extra benefit or
utility that a person derives with increase in the consumption of a good, diminishes with each
additional unit of the good consumed”

Clearly, it is marginal utility, and not total utility, that determines the consumer’s willing-to-pay price.
Since we consume few diamonds, the MU is high, and consumers are willing to pay a high price. This
can be seen by looking at the marginal utility curves for water in figure 2 and for diamonds in figure 3
respectively.