1 Introduction to Micro and Macro Economics

Let's recall : likely the first person to have referred to the

You have already studied in Class XI, study of individual firm and producer as
the meaning and definitions of economics “Microeconomics.” Moreover, he referred
given by different economists. to the study of the aggregate economy as
“Macroeconomics.”

You should know :

Historical review of Micro Economics :
Micro Economic analysis was developed
first. It is a traditional approach. Origin
of this approach can be traced back to the
era of Classical Economists- Adam Smith,
David Ricardo, J. S. Mill etc.
Fig. 1.1 It was popularized by Neo-Classical
Introduction : Economist, Prof. Alfred Marshall in his
Micro economics and Macro economics are book, 'Principles of Economics', published
the two main branches of modern economics. in 1890. Other economists like Prof. Pigou,
The term ‘micro’ is derived from the Greek word, J. R. Hicks, Prof. Samuelson, Mrs. Joan
‘Mikros’ which means small or a millionth part. Robinson, etc. have also contributed to the
The term ‘macro’ is derived from the Greek development of Micro Economics.
word, ‘Makros’ which means large. These terms Historical Review of Macro Economics :
were coined by Norwegian Economist Ragnar Macro Economics did exist in the past
Frisch of Oslo University in 1933. before the evolution of Micro Economics.
Main Branches of Economics In the 16th and 17th century, followers
of Mercantilists (a group of English
merchants) advocated policies to the
Micro Economics Macro Economics
government which were based on macro
Do you know? approach. In the 18th century, Physiocrats
Ragnar Anton Kittil Frisch (1895-1973), (French Thinkers) tried to analyse the
a Norwegian econometrician concept of national income and wealth.
and economist was a joint Even the Classical Economic theories
winner with Jan Tinbergen of Prof. Adam Smith, Prof. Ricardo and
of the first Nobel Prize for Prof. J. S. Mill discussed the determination
Economics in 1969. He was of national income and wealth. But their
a pioneer of econometrics- macro analysis was combined with micro
the application of mathematical models and analysis. Thus, micro analysis ruled the
statistical techniques to economic data and world of economics till the Great Depression
theories. He coined many economic terms. of 1930s.
In an article on business cycles, Frisch was After the Great Depression, Lord John

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 (a) Theory of Product Pricing : The price of
Maynard Keynes published his famous
an individual commodity is determined by
book the "General Theory of Employment,
Interest and Money" in 1936. Keynes the market forces of demand and supply.
used macro economic approch to analyse Micro economics is concerned with demand
economic problems. The credit for the analysis i.e. individual consumer behaviour,
development of macro economic approach and supply analysis i.e. individual producer
goes to Lord Keynes. Besides Keynes, behaviour.
Malthus, Wicksell, Walras, Irving Fisher
are other economists who have contributed (b) Theory of Factor Pricing : In Micro
to the development of macro economics. economics, land, labour, capital and
entrepreneur are the factors that contribute
Meaning of Micro Economics : to the production process. Micro economics
Micro means a small part of a thing. Micro helps in determining the factor rewards for
economics thus deals with a small part of the
land, labour, capital, and entrepreneur in
national economy. It studies the economic
the form of rent, wages, interest, and profit
actions and behaviour of individual units such
as an individual consumer, individual producer respectively.
or a firm, the price of a particular commodity or (c) Theory of Economic Welfare : Theory of
a factor etc. Welfare basically deals with efficiency in
Definitions of Micro Economics : the allocation of resources. Efficiency in the
You have already studied some important allocation of resources is attained when it
definitions of micro economics, let us review results in maximization of satisfaction of
some more definitions : the people. Economic efficiency involves
1) Maurice Dobb - “Micro economics is in three efficiencies :
fact a microscopic study of the economy.” • Efficiency in production : Efficiency in
2) Prof A. P. Lerner - “Micro economics production means producing maximum
consists of looking at the economy through possible amount of goods and services from
a microscope, as it were, to see how the the given amount of resources.
millions of cells in the body of economy –
• Efficiency in consumption : Efficiency
the individuals or households as consumers
in consumption means distribution of
and individuals or firms as producers play
their part in the working of the whole produced goods and services among the
economic organism.” people for consumption in such a way as to
The following chart gives an idea of the maximize total satisfaction of the society.
scope of micro economics. • Overall economic efficiency : It means the
production of those goods which are most
Scope of Micro Economics
desired by the people.
Micro economic theory shows under what
Theory of Theory of Theory of
Product Pricing Factor Pricing Economic conditions these efficiencies are achieved.
Rent Welfare Thus, the focus of micro economics
Demand Supply Wages is mainly confined to price theory and
Analysis Analysis Interest
resource allocation. It does not study the
Profit
aggregates relating to the whole economy.
Efficiency in Efficiency in Overall Economic This approach does not study national
Production Consumption Efficiency
economic problems such as unemployment,
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 poverty, inequality of income etc. Theory of an additional unit. Marginal analysis helps
growth, theory of business cycles, monetary to study a variable through the changes.
and fiscal policies etc. are beyond the limits Producers and consumers take economic
of micro economics. decisions using this principle.
Features of Micro Economics : 7) Analysis of Market Structure : Micro
1) Study of Individual Units : Micro economics analyses different market
economics is the study of the behaviour structures such as Perfect Competition,
of small individual economic units, like Monopoly, Monopolistic Competition,
individual firm, individual price, individual Oligopoly etc.
household etc. 8) Limited Scope : The scope of micro
2) Price Theory : Micro economics deals with economics is limited to only individual
determination of the prices of goods and units. It doesn’t deal with the nationwide
services as well as factors of production. economic problems such as inflation,
Hence, it is known as price theory. deflation, balance of payments, poverty,
3) Partial Equilibrium : Equilibrium is unemployment, population, economic
the balance between two factors. Micro growth etc.
economic analysis deals with partial Importance of Micro Economics :
equilibrium which analyses equilibrium 1) Price Determination : Micro economics
position of an individual economic unit explains how the prices of different
i.e. individual consumer, individual firm, products and various factors of production
individual industry etc. It isolates an are determined.
individual unit from other forces and studies
2) Free Market Economy : Micro economics
its equilibrium independently.
helps in understanding the working of a free
4) Based on Certain Assumptions : Micro
market economy. A free market economy
economics begins with the fundamental
is that economy where the economic
assumption, “Other things remaining
decisions regarding production of goods,
constant” (Ceteris Paribus) such as perfect
such as ‘What to produce?, How much to
competition, laissez-faire policy, pure
produce?, How to produce? etc.’ are taken
capitalism, full employment etc. These
at individual levels. There is no intervention
assumptions make the analysis simple.
by the Government or any other agency.
5) Slicing Method : Micro economics uses
slicing method. It splits or divides the whole 3) Foreign Trade : Micro economics helps
economy into small individual units and in explaining various aspects of foreign
then studies each unit separately in detail. trade like effects of tariff on a particular
For example, study of individual income commodity, determination of currency
out of national income, study of individual exchange rates of any two countries, gains
demand out of aggregate demand etc. from international trade to a particular
country etc.
6) Use of Marginalism Principle : The
concept of Marginalism is the key tool 4) Economic Model Building : Micro
of micro economic analysis. The term economics helps in understanding various
'marginal' means change brought in total by complex economic situations with the help

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 of economic models. It has made a valuable 2) Prof Carl Shapiro - “Macro economics
contribution to economics by developing deals with the functioning of the economy
various terms, concepts, terminologies, tools as a whole.”
of economic analysis etc. Economic models The following chart gives an idea about
are built using various economic variables. the scope of macro economics.
Scope of Macro Economics
5) Business Decisions : Micro economic
theories are helpful to businessmen for
Theory of Theory of Theory of Macro
taking crucial business decisions. These Income and General Economic Theory of
decisions are related to the determination Employment Price Growth and Distribution
of cost of production, determination of Level and Development
Inflation
prices of goods, maximization of output
Theory of Theory of
and profit, etc.
Consumption Investment
6) Useful to Government : It is useful to Function Function
government in framing economic policies Theory of
such as taxation policy, public expenditure Business Cycles
policy, price policy etc. These policies i) Theory of Income and Employment :
help the government to attain its goals Macro economic analysis explains which
of efficient allocation of resources and factors determine the level of national
promoting economic welfare of the society. income and employment and what causes
7) Basis of Welfare Economics : Micro fluctuations in the level of income, output and
economics explains how best results can employment. To understand, how the level of
be obtained through optimum utilization employment is determined, we have to study
of resources and its best allocation. It also the consumption function and investment
studies how taxes affect social welfare. function. Theory of Business Cycles is also a
part and parcel of the Theory of Income and
Meaning of Macro Economics :
Employment.
Macro economics is the branch of
economics which analyses the entire economy. ii) Theory of General Price Level and
It deals with the total employment, national Inflation : Macro economic analysis shows
income, national output, total investment, total how the general price level is determined and
consumption, total savings, general price level further explains what causes fluctuations
interest rates, inflation, trade cycles, business in it. The study of general price level is
fluctuations etc. Thus, macro economics is the significant on account of the problems
study of aggregates. created by inflation and deflation.
iii) Theory of Growth and Development :
Definitions of Macro Economics :
Macro economics consists of the theory
1) J. L. Hansen - “Macro economics is that of economic growth and development. It
branch of economics which considers the explains the causes of underdevelopment
relationship between large aggregates such and poverty. It also suggests strategies for
as the volume of employment, total amount accelerating growth and development.
of savings, investment, national income
iv) Macro Theory of Distribution : Macro
etc.”
theory of distribution deals with the relative
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 shares of rent, wages, interest and profit in various factors that contribute to economic
the total national income. growth and development. It is useful in
Features of Macro Economics : developing growth models. These growth
models are used for studying economic
1) Study of Aggregates : Macro economics
development. For example, Mahalanobis
deals with the study of economy as a whole.
growth model emphasized on basic heavy
It is concerned with the aggregate concepts
industries.
such as national income, national output,
national employment, general price level, 7) General Price Level : Determination and
business cycles etc. changes in general price level are studied in
macroeconomics. General price level is the
2) Income Theory : Macro economics studies
average of all prices of goods and services
the concept of national income, its different
currently being produced in the economy.
elements, methods of measurement and
8) Policy-oriented : According to Keynes,
social accounting. Macro economics deals
macro economics is a policy oriented
with aggregate demand and aggregate
science. It suggests suitable economic
supply. It explains the causes of fluctuations
policies to promote economic growth,
in the national income that lead to business
generate employment, control of inflation,
cycles i.e. inflation and deflation.
and depression etc.
3) General Equilibrium Analysis : Macro
Importance of Macroeconomics :
economics deals with the behaviour of
1) Functioning of an Economy : Macro
large aggregates and their functional
economic analysis gives us an idea of the
relationship. General Equilibrium deals
functioning of an economic system. It helps
with the behaviour of demand, supply and
us to understand the behaviour pattern
prices in the whole economy.
of aggregative variables in a large and
4) Interdependence : Macro analysis takes complex economic system.
into account interdependence between
2) Economic Fluctuations : Macro economics
aggregate economic variables, such as
helps to analyse the causes of fluctuations
income, output, employment, investments,
in income, output and employment and
price level etc. For example, changes in
makes an attempt to control them or reduce
the level of investment will finally result
their severity.
into changes in the levels of income, levels
of output, employment and eventually the 3) National Income : Study of macro
level of economic growth. economics has brought forward the immense
importance of the study of national income
5) Lumping Method : Lumping method is the
and social accounts. Without a study
study of the whole economy rather than its
of national income, it is not possible to
part. According to Prof. Boulding, “Forest
formulate correct economic policies.
is an aggregation of trees but it does not
4) Economic Development : Advanced studies
reveal the properties of an individual tree.”
in macro economics help to understand the
This reveals the difference between micro
problems of developing countries such as
economics and macro economics.
poverty, inequalities of income and wealth,
6) Growth Models : Macro economics studies differences in the standards of living of the

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 people etc. It suggests important steps to
achieve economic development. Tools Individual Aggregate
Demand and Demand and
5) Performance of an Economy : Macro
Individual Aggregate
economics helps us to analyse the
Supply Supply
performance of an economy. National
Income (NI) estimates are used to measure Scope Demand, National
the performance of an economy over time supply, prod- income,
by comparing the production of goods and uct pricing, general
services in one period with that of the other factor pricing, price level,
period. production, employment,
consumption, money etc.
6) Study of Macro economic Variables : To
economic
understand the working of the economy,
welfare, etc.
study of macro economic variables are
important. Main economic problems are Importance Price Economic
related to the economic variables such determination, fluctuations,
as behaviour of total income, output, Model Study of
employment and general price level in the building, national
economy. Business income,
decisions etc. Economic
7) Level of Employment : Macro economics development
helps to analyse the general level of etc.
employment and output in an economy.
Theory Price Theory Income and
You should know : Employment
Theory
Micro Economics and Macro Economics
Examples Individual National
at a glance
income, income,
Basis for Micro Macro Individual National
comparison economics economics
output etc. output etc.
Meaning Micro Macro
economics economics
studies the studies the Try this :
behaviour of behaviour of 1) Visit the vegetable market in the nearest
individual aggregates of area and try to get information about
unit of an the economy income and expenditure items of a
economy as a whole particular seller

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 EXERCISE

Q. 1. Choose the correct option : 4) Makros : Macro economics : : Mikros :

1) The branch of economics that deals with the 5) General equilibrium : Macro economics ::
allocation of resources. : Micro economics
a) Micro economics b) Macro economics
Q. 3. Identify and explain the concepts from the
c) Econometrics d) None of these
given illustrations :
Options :1) a, b and c 2) a and b
1) Gauri collected the information about the
3) only a 4) None of these income of a particular firm.
2) Concepts studied under Micro economics. 2) Ramesh decided to take all decisions related to
a) National income b) General price level production, such as what and how to produce?
c) Factor pricing d) Product pricing 3) Shabana paid wages to workers in her factory
Options :1) b and c 2) b, c and d and interest on her bank loan.
3) a, b and c 4) c and d Q. 4. Answer the following :
3) Method adopted in micro economic analysis. 1) Explain the features of Micro economics.
a) Lumping method b)Aggregative method 2) Explain the importance of Macro economics.
c) Slicing method d) Inclusive method 3) Explain the scope of Macro economics.
Options :1) a, c and d 2) a, b and d
Q. 5. State with reasons whether you agree or
3) only c 4) only a
disagree with the following statements :
4) Concepts studied under Macro economics.
1) The scope of micro economics is unlimited.
a) Whole economy b) Economic development
2) Macro economics deals with the study of
c) Aggregate supply d) Product pricing
individual behaviour.
Options :1) a, b and c 2) b, c and d
3) Macro economics is different from micro
3) only d 4) a, b, c and d
economics.
Q. 2. Complete the correlation : 4) Micro economics uses slicing method.
1) Micro economics : Slicing method : : Macro 5) Micro economics is known as Income theory.
economics :
2) Micro economics : Tree : : Macro economics : Q. 6. Answer in detail :
1) Explain the importance of Micro economics.
3) Macro economic theory : Income and 2) Explain the concept of Macro economics and
employment : : Micro economics : its features.



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 2 Utility Analysis

Let's recall : 2) Subjective concept : It is a psychological

concept. Utility differs from person to
1) Want denotes a feeling of lack of
person. This is due to differences in taste,
satisfaction.
preferences, likes, dislikes, nature, habits,
2) Wants are unlimited.
profession etc. For example, stethoscope
3) They are recurring in nature.
has utility to a doctor but not to a layman.
4) They differ with age, gender, seasons,
habits and culture. 3) Ethically neutral concept : The concept of
5) Utility is the capacity of a commodity utility has no ethical consideration. It is a
morally colourless concept. The commodity
to satisfy human wants. In other words,
should satisfy any want of a person without
utility is the want satisfying power of a
consideration of what is good or bad,
good.
desirable or undesirable. For example, a
Introduction : knife has utility to cut fruits and vegetables
You have been already introduced to the as well as it can be used to harm someone.
concept of utility in class XI. This unit gives a Both wants are of different nature but are
detailed explanation of consumer’s behaviour. satisfied by the same commodity. Thus,
In practice, every individual tries to utility is ethically neutral.
satisfy his wants with available resources. 4) Utility differs from usefulness : Utility
It is true that all human wants cannot be is the capacity of a commodity to satisfy
satisfied fully at a specific time. Utility analysis human wants, whereas usefulness indicates
explains a consumer’s behaviour in relation to value in use of the commodity. For example,
maximization of satisfaction. milk has both utility as well as usefulness to
a consumer, while liquor has utility only to
Try this : an addict, but has no usefulness.
1) Make a list of 10 commodities which 5) Utility differs from pleasure : A
satisfy your wants. commodity may possess utility but it may
2) Make a list of 10 commodities which not give any pleasure to the consumer. For
satisfy the wants of particular individuals example, injection for a patient has utility
performing specific activities. For because it cures the ailment but it hardly
example, A chalk has utility for a teacher. gives any enjoyment or pleasure to him.
6) Utility differs from satisfaction : Utility
Features of Utility : is a cause of consumption, satisfaction is
Following are the features of utility : the end result of consumption. They are
1) Relative concept : Utility is related to interrelated but still different concepts. For
time and place. It varies from time to example, a thirsty person drinks a glass
time and place to place. For example, (i) of water since water has the capacity to
woollen clothes have a greater utility in the satisfy thirst. Utility of water is the cause of
winter. (ii) sand has greater utility at the consumption and the satisfaction derived is
construction site than at the sea shore. the end result of consumption.

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 7) Measurement of utility is hypothetical : 2) Place utility : When utility of a commodity
Utility is an abstract concept. Cardinal or increases due to a change in its place, it is
numerical measurement of utility is not called place utilities. For example, woollen
possible. For example, a thirsty person clothes have more utility at cold places than
after drinking water, may derive higher or at warm places. Transport creates place
lower level of utility. Thus, utility can only utility.
be experienced and found either positive,
zero or negative. Negative utility is called
disutility.
8) Utility is multi-purpose : A commodity
can satisfy the want of more than one
person, it can also be put to several uses.
For example, electricity can be used to
serve many purposes and for many people Fig. 2.2
at some point of time. 3) Service utility : Service utility arises when
9) Utility depends on the intensity of want : personal services are rendered by various
Utility depends on the intensity of a want. professionals. For example, services of
More intense the want, greater will be the doctors, teachers, lawyers etc.
utility. As and when the urgency of want
declines, utility diminishes. For example,
a hungry person finds more utility in food,
than a person who is not hungry.
10) Utility is the basis of demand : A person
will demand a commodity only if it gives
utility to him. For example, a sick person
has utility in medicines hence, he demands
medicines. Fig. 2.3

Types of Utility : 4) Knowledge utility : When a consumer

Following are some of the different types of utility acquires knowledge about a particular
1) Form utility : When utility is created due product, it is called knowledge uitility. For
to a change in the shape or structure of an example, utility of a mobile phone or a
existing material, it is called form utility. computer increases when a person knows
For example, toys made of clay, furniture about its various functions.
from
mw wood
ood etc.
oo

Fig. 2.1 Fig. 2.4

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5) Possession utility : Possession utility arises
Try this :
when the ownership of goods is transferred
Following are the various types of utility
from one person to another. For example,
and their respective examples. Arrange the
transfer of goods from the sellers to the
information in the form of pairs:
buyers..
Types of utility : Time utility, possession
utility, service utility and place utility.
Examples : 1) A dentist giving dental
treatment to a patient.
2) A mountaineer using oxygen cylinder at
a high altitude.
3) A farmer selling rice stored in the
Fig. 2.5 warehouse at the end of the season.
4) A retail trader purchasing 100 chairs
6) Time utility : When the utility of a
from the wholesale trader.
commodity increases with a change in its
time of utilization, it is called time utility. Concepts of Utility :
For example, a student has more utility for Following are the two main concepts of
text books during examinations than in the utility :
vacations. Time utility is also observed 1) Total Utility (TU) : Total utility refers
when goods are stored and used at the time to the aggregate of utility derived by the
of scarcity. For example, Blood bank. consumer from all units of a commodity
consumed. It is an aggregate of utilities
from all successive units of a commodity
consumed.
2) Marginal Utility (MU) : Marginal utility
refers to the additional utility derived by
a consumer from an additional unit of a
commodity consumed. In other words, it
is the addition made by the last unit of a
Fig. 2.6 A commodity consumed.

Fig. 2.6 B Fig. 2.6 C Fig. 2.6 D

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 TU Curve = Total Utility Curve
You should know :
Formulae explaining the relationship MU Curve = Marginal Utility Curve
between total utility and marginal utility : X axis measures the units of the commodity
TU = 6 MU or consumed while Y axis indicates the figures of
TU = MU1 + MU2 + MU3 ……….. + MUn
total and marginal utility.
MUn = TUn – TU(n–1)
Where TU = Total Utility Fig. 2.7 shows that total utility curve slopes
MU = Marginal Utility upwards whereas marginal utility curve slopes
MU1, MU2, MU3 = Marginal Utility of each unit. downwards. Marginal utility curve shows zero
MUn = Marginal Utility of nth unit. and negative levels of marginal utility whereas
TUn = Total Utility at nth level. total utility curve shows maximum and constant
TU(n–1) = Total Utility at previous level. total utility level.
Relationship between Total Utility and 1) Total utility and marginal utility of the very
Marginal Utility : first unit of x consumed, are the same.
Marginal utility derived from various 2) As the consumer consumes further
units of a commodity and its total utility are units of x, the total utility increases at a
interrelated. This can be easily followed from diminishing rate and marginal utility goes
the hypothetical example given in the table 2.1 on diminishing. (TUK MUL)
Table 2.1 Utility Schedule 3) At a particular stage, total utility reaches to
Units of x Total utility Marginal utility
1 10 10
its maximum and remains constant whereas
2 18 8 marginal utility becomes zero. This is called
3 24 6 the point of satiety. (TU highest, MU = 0)
4 28 4
4) After this point, any additional unit
5 30 2
6 30 0 consumed further results in a decline in the
7 28 –2 total utility, while marginal utility becomes
Table 2.1 explains the relationship between negative. (TUL MU negative)
total utility and marginal utility. 5) After reaching the point of satiety, a rational
On the basis of Table 2.1 Total utility and consumer should stop his consumption
Marginal Utility curves (TU and MU) can be since the maximum limit of satisfaction is
derived with the following diagram. reached and there is no addition to total
Y Point of satiety
32 utility by any further increase in the stock
S
28
of a commodity.
TU
24 Curve 6) Consumption beyond the point of satiety
Total and Marginal utility

transforms satisfaction into dissatisfaction.

20
In other words, a consumer starts
16
experiencing ill effects of consumption.
12

8 Try this :
Complete the following chart with proper
4
statement and bring about the difference
0 1 2 3 4 5 6 7 X between the two concepts i.e total utility
MU
-4 Disutility Curve and marginal utility.
Units of Commodity x Fig. 2.7
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 which a person derives from a given increase
Total Utility Marginal Utility in his stock of a thing, diminishes with every
1) Total utility is the 1) Marginal utility increase in the stock that he already has.”
sum total of the is the addition In other words, marginal utility that any
individual utilities made to the total
consumer derives from successive units of a
derived from the utility from every
consumption of a additional unit particular commodity goes on diminishing as
single unit of good. consumed. his or her total consumption of that commodity
2) Total utility 2) increases. In short, the more of a thing you have,
increases at a the less you want to have more of it.
diminishing rate.
Assumptions :
3) 3) At the point of Following are the assumptions of the law of
satiety MU = O
diminishing marginal utility :
4) Total utility 4) 1) Rationality : Consumer is assumed to
declines if be rational. It means that his behaviour
consumption is normal and he tries to maximize his
continues.
satisfaction.
5) Total utility deter- 5)
mines value in use 2) Cardinal measurement : The law assumes
of a commodity. that utility can be cardinally or numerically
6) 6) Marginal utility measured. Hence, mathematical operations
can be positive, are easily possible to know and compare
negative, zero. the utility derived from each unit of a
7) Diagram : 7) Diagram : commodity.
y
3) Homogeneity : All units of a commodity
4 consumed are exactly homogeneous or
TU

TU curve identical in size, shape, colour, taste etc.

2
4) Continuity : All units of commodity are
0 Units x consumed in quick succession without any
lapse of time.
Law of Diminishing Marginal Utility : 5) Reasonability : All the units of a commodity
Introduction : consumed are of reasonable size. They are
This law was first proposed by Prof. Gossen neither too big nor too small.
but was discussed in detail by Prof. Alfred 6) Constancy : All the related factors like
Marshall in his book ‘Principles of Economics’ income, tastes, habits, choices, likes,
published in 1890. dislikes of a consumer should remain
The law of diminishing marginal utility constant. Marginal utility of money is also
is universal in character. It is based on the assumed to be constant.
common consumer behaviour that utility derived 7) Divisibility : The law assumes that the
diminishes with the reduction in the intensity of commodity consumed by the consumer is
a want. divisible so that it can be acquired in small
Statement of the Law : quantities.
According to Prof. Alfred Marshall, “Other 8) Single want : A given commodity can
things remaining constant, the additional benefit satisfy a single want of a person. The law
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 assumes an experience of a single want brings disutility (negative utility) which is shown
which is completely satiable at a given by the shaded portion in the diagram.
point of time. Exceptions to the Law of Diminishing
Table 2.2 explains the Law of Diminishing Marginal Utility :
Marginal Utility.
Following are the exceptions to the law of
Table : 2.2
diminishing marginal utility :
Units of x Marginal Utility (MU)
1 10 1) Hobbies : In certain hobbies like collection
2 8 of various stamps and coins, rare paintings,
3 6 music, reading etc., the law does not hold
4 4 true because every additional increase in the
5 2 stock gives more pleasure. This increases
6 0 marginal utility. However, this violates the
7 –2 assumption of homogeneity and continuity.
The table shows that marginal utility keeps 2) Miser : In the case of a miser, every
on diminishing with increase in consumption, additional rupee gives him more and more
further it becomes zero and then negative. satisfaction. Marginal utility of money
Y tends to increase with an increase in his
MU MU = Marginal Utility Curve
10 stock of money. However, this situation
ignores the assumption of rationality.
8
Marginal utility

3) Addictions : It is observed in case of a

6
drunkard that the level of intoxication
4 increases with every additional unit of
2 liquor consumed. So MU received by
drunkard may increase. Actually it is
0 1 2 3 4 5 6 7 X only an illusion. This condition is similar
-2 MU
Disutility to almost all addictions. However, this
Units of Commodity x violates the assumption of rationality.
Fig. 2.8 4) Power : This is an exception to the law
Explanation of the Diagram : because when a person acquires power, his
In the above diagram, units of commodity x lust for power increases. He desires to have
are measured on X axis and marginal utility is more and more of it. However, this again
measured on Y axis. Various points of MU are violates the rationality assumption.
plotted on the graph as per the given schedule. 5) Money : It is said that the MU of money
When the locus of all the points is joined, MU never becomes zero. It increases when the
curve is derived. stock of money increases. This is because
MU curve slopes downwards from left to money is a medium of exchange which is
right which shows that MU goes on diminishing used to satisfy various wants. However,
with every successive increase in the consumption according to some economists, this law
of a commodity. is applicable to money too. For example,
When MU becomes zero, MU curve intercepts marginal utility of money is more to a poor
the X axis. Further consumption of a commodity person than to a rich person.

13
 However, these, exceptions are only resources, it is necessary to ‘diversify’ the
apparent. Since they violate some or the consumption.
other assumptions of the law and hence, 2) Useful to the government : The law is
they are not real exceptions. useful to the government in framing various
Criticisms of the Law : policies such as progressive tax policy,
The law of diminishing marginal utility is trade policy, pricing policy etc.
criticised on the following grounds. 3) Basis of paradox of values : The law
1) Unrealistic assumptions : The law of of diminishing marginal utility helps us
diminishing marginal utility is based upon to understand the paradox of values. It
various assumptions like homogeneity, includes goods that have more value-in-use
continuity, constancy, rationality etc. but and zero or less value-in-exchange such as
in reality it is difficult to fulfil all these air, water, sunshine etc. as well as goods
conditions at a point of time. that have more value-in-exchange and less
value-in-use such as gold, diamonds etc.
2) Cardinal measurement : The law assumes
4) Basis of law of demand : The law of demand
that utility can be expressed cardinally so
is based on the law of diminishing marginal
it can be added, compared and presented
utility. According to the law of demand, the
through a schedule. In reality cardinal
quantity demanded of a good rises with a
measurement of utility is not possible
fall in price and falls with an increase in
because utility is a psychological concept.
price. When a consumer purchases more
3) Indivisible goods : The law is not and more units of a good, its marginal
applicable to indivisible and bulky goods utility steadily declines. Hence, he would
like refrigerator, car, TV sets etc. which are buy additional units of a commodity only
normally purchased in single unit at a time. at a lower price.
4) Constant marginal utility of money : The
law assumes that MU of each unit of money Try this :
remains constant. However, critics argue Write an informative note on paradox of
that MU of money differs from person to values along with examples.
person. It is influenced by changes in prices, Relationship between Marginal Utility and
stock of money etc. Price :
5) A single want : The law is restricted to Let us discuss the relationship between
the satisfaction of a single want at a point marginal utility and price in order to understand
of time. However, in reality, a man has to how the law of diminishing marginal utility
satisfy many wants at a point of time. forms the basis of law of demand. It is a perfect
Significance of the Law : example of practical application of the law of
In spite of the criticisms, the law of Diminishing Marginal Utility (DMU).
diminishing marginal utility is a very popular To understand the relation, it is essential
and an important law in Economics because of to convert marginal utility in terms of money so
its universal application. that it can be compared with market price.
1) Usefulness to the consumers : This law Let us assume : One unit of marginal utility =
creates awareness among the consumers. ` 10.
To obtain maximum utility from the limited Market price per unit of x = ` 50.
14
 Table 2.3 marginal utility and price :
No MU/ MU in terms Market Comparison 1) Units which a consumer willingly buys
of units of money price/unit between MU because MU is greater than price are called
units of x 1unit = ` 10 of x = ` 50 and price
“Intra-marginal units” (MUx>Px)
1 10 100 (10 × `10 ) ` 50 100 MU> `50
2) Unit at which MU becomes equal
2 8 80 (8 × ` 10 ) ` 50 80 MU> `50
with market price is “marginal unit”.
3 7 70 (7 × ` 10 ) ` 50 70 MU> `50 (MUx=Px) = Consumer’s equilibrium
4 5 50 (5 × ` 10 ) ` 50 50 MU = `50 3) Units which a rational consumer is not
5 3 30 (3 × ` 10 ) ` 50 30 MU< `50 willing to buy and consume where he has
6 1 10 (1 × ` 10 ) ` 50 10 MU< `50 to pay more than the MU are called “Extra-
marginal units.” (MUx<Px)
Table 2.3 explains the relationship between Thus, a rational consumer attains
marginal utility (MU) and price. equilibrium where MUx=Px. This relationship
The table shows that a consumer between marginal utility and price paved way
starts buying units of commodity x for his for law of demand.
consumption, one after the other. Marginal
utility which is added to his stock goes on Do you know?
diminishing with every further unit consumed. Two English Economists, J. R. Hicks
When MU is converted in terms of money, one and R. G. D. Allen were
can easily compare it with market price which is the main exponents of
shown in the column 5 of the table 2.3 ‘Indifference Method’. It
For the first three units consumed, it is was evolved to supersede
found that marginal utility in terms of money is cardinal utility analysis
greater than the price paid. A rational consumer given by Prof. Alfred
will willingly buy these units since the benefit J R Hicks Marshall. Indifference curve
derived is more than the price paid. At the 4th analysis adopts the concept
unit marginal utility and price become equal. of ordinal utility.
So the consumer can also think of buying the An indifference curve is
4th unit. In the case of 5th and 6th units, marginal the locus of points indicating
utility derived is less than the market price paid. particular combinations of
A rational consumer will not buy further once two goods from which the
the equality between marginal utility and price consumer derives the same
R.G.D Allen
is established. level of satisfaction. As
From the given table 2.3, following a result, he is indifferent to the particular
inferences can be made with reference to combination that he consumes.

15
 EXERCISE

Q. 1. A) Complete the following statements by 2) Statments indicating consumer equilibrium :

choosing the correct alternatives. a) MU is greater than price
1) In the law of diminishing marginal utility, b) MU is equal to price
Alfred Marshall assumes that marginal utility c) MU is less than price
of money………. d) Price is less than one
a) increases b) remains constant Options :
c) decreases d) rises and then falls i) a and b ii) a, b, c and d
iii) a, b and c iv) only b
2) As per the law of diminishing marginal utility,
measurement of utility is assumed to be ………. Q. 3. Identify and explain the concepts from the
given illustration :
a) ordinal
1) Salma purchased sweater for her father in
b) cardinal
winter season.
c) both ordinal and cardinal
2) Nilesh purchased ornaments for his sister.
d) none of the above
3) Kavita consumed five units of oranges one after
3) MU of the commodity becomes negative when the other.
TU of a commodity is ……… 4) Bhushan refused to eat fifth chapati after eating
a) rising b) constant c) falling d) zero four chapatis.
5) Lalita satisfied her want of writing on essay by
4) Point of Satiety means ……….
using pen and notebook.
a) TU is rising and MU is falling
Q. 4. Observe the given table and answer the
b) TU is falling and MU is negative
questions:
c) TU is maximum and MU is zero Unit of a commodity TU units MU units
d) MU is falling and TU is rising. 1 6 6
2 11 5
5) When MU is falling, TU is……….
3 15 4
a) rising b) falling 4 15 0
c) not changing d) maximum 5 14 –1
1) Draw total utility curve and marginal utility
Q. 2. Choose the correct option :
curve.
1) A B
1) Time utility a) Transport 2) a) When total utility is maximum marginal
utility is
2) Place utility b) Blood Bank
3) Service utility c) Mobile phone b) When total utility falls, marginal utility
becomes
4) Knowledge utility d) Doctor
Options : Q. 5. Answer in detail :
i) 1-d, 2-b, 3-a, 4-c ii) 1-b, 2-a, 3-d, 4-c 1) State and explain the law of diminishing
iii) 1-a, 2-b, 3-c, 4-d iv) 1-b, 2-c, 3-d, 4-a marginal utility with exceptions.



16
 3A Demand Analysis

Introduction : Demand Schedule :

You have already studied the concept of Demand schedule is a tabular representation
utility in the previous chapter. Utility is the basis of the functional relationship between price and
of demand. Utility may generate a desire or a quantity demanded for a particular commodity.
need to have a particular commodity, but utility A demand schedule may be either individual
on its own cannot generate demand for the demand schedule or market demand schedule.
commodity. This chapter is an effort to analyse Individual Demand Schedule :
the concept of demand. Demand analysis is Individual demand is the quantity of a
concerned with consumer behaviour. commodity demanded by a consumer at a given
Meaning of Demand : price during a given period of time.
In ordinary language, demand means a Individual demand schedule is a tabular
desire. Desire means an urge to have something. representation showing different quantities of
In Economics, demand means a desire which is commodities that an individual consumer is
backed by willingness and ability to pay. prepared to buy at various prices over a given
For example, if a person has the desire to period of time.
purchase a television set but does not have This can be explained with the help of the
the adequate purchasing power then it will be following individual demand schedule.
simply a desire and not a demand. Individual demand schedule :
Thus, demand is an effective desire. All Table 3.1
desires are not demand. Price of commodity Quantity demanded of
In short, ‘x’ ( ` ) commodity ‘x’ (in kgs)
Demand = Desire + willingness to 10 1
purchase + Ability to pay. 8 2
6 3
Try this : 4 4
2 5
Identify the concepts :
Table 3.1 shows different quantities of
1) A poor person wants to have a car ……
commodity ‘x’ purchased by an individual
2) A rich person bought a car ……
consumer at various prices. It can be observed
that less quantity of commodity is demanded at
Definition of Demand :
rising prices and more quantity of commodity
According to Benham, “the demand for
is demanded at falling prices. It indicates an
anything at a given price is the amount of it, inverse relationship between price and quantity
which will be bought per unit of time at that demanded.
price.”
Individual Demand Curve :
Thus, following are the features of demand :
Individual demand curve is a graphical
1) Demand is a relative concept. representation of the individual demand
2) Demand is essentially expressed with schedule.
reference to time and price. Fig. 3.1 represents an individual demand curve
17
 which is based on table 3.1 the demand of all consumers at various prices.
Individual Demand Curve It also indicates an inverse relationship between
price and quantity demanded.
Y
This can be explained with the help of
D DD = Demand Curve
10 following market demand schedule.
8 Market demand schedule :
Price in `

Table. 3.2
6
Price of Quantity of ‘x’ Market
4 commodity demanded Kgs. demand
Con- Con- Con-
2 D ‘x’( ` ) A+B+C
sumer sumer sumer
A B C
0 1 2 3 4 5 6 7 X
10 5 10 15 30
Quantity Demanded in (Kgs) 8 10 15 20 45
Fig. 3.1 6 15 20 25 60
4 20 25 30 75
In figure 3.1, X axis represents quantity
2 25 30 35 90
demanded and Y axis represents the price of
the commodity. The demand curve DD slopes Table 3.2 shows different quantities of
downward from left to right, indicating an commodity x purchased by different consumers
inverse relationship between price and quantity (A, B, C) at various prices. It can be observed
demanded. that less quantity of commodity is demanded at
rising prices and more quantity of commodity
is demanded at falling prices. Thus, there is an
inverse relationship between price and quantity
demanded.
Market Demand Curve :
Graphically, the market demand curve is
a horizontal summation of individual demand
curves. It is based on the market demand schedule.
Fig. 3.3 represents the market demand curve
Market Demand Curve
Y DD = Market Demand Curve
D
Fig. 3.2 Individual Demand 10
Market Demand Schedule : 8
Price in `

Market demand is total demand for a

6
commodity from all the consumers at a given
price during a given period of time. 4
Market demand schedule is a tabular 2 D
representation showing different quantities of
commodity which all consumers are prepared to 0 20 40 60 80 100 X
buy at various prices over a given period of time. Quantity Demanded in (Kgs)
It is obtained by a horizontal summation of Fig. 3.3
18
 In figure 3.3, X axis represents market 4) Multi-purpose uses : When a commodity
demand and Y axis represents the price of the can be used for satisfying several needs, its
commodity. The market demand curve ‘DD’ demand will rise with a fall in its price and
slopes downward from left to right, indicating an fall with a rise in its price.
inverse relationship between price and market 5) New Consumers : When the price of a
demand
demand.
ndd. commodity falls, a new consumer class
appears who can now afford the commodity.
Thus, total demand for commodity increases
with fall in price.

Try this :
Complete the following hypothetical
demand schedule.
Price of commodity ‘x’(`) Qty. Demanded kgs
350 3
300
250 10
Fig. 3.4 Market Demand 200
Try this : 150
Prepare a monthly demand schedule of
100 30
your family for various commodities. For
example, vegetables, fruits, medicines etc. Types of Demand :
Reasons justifying downward sloping demand 1) Direct demand
curve are as follows : 2) Indirect demand
Types of
1) Law of Diminishing Marginal Utility : 3) Complementary/ Joint demand
Demand
We have seen that marginal utility goes on 4) Composite demand
diminishing with an increase in the stock 5) Competitive demand
of a commodity and vice-versa. Therefore,
a consumer tends to buy more when price 1) Direct demand : It is the demand by
falls and vice-versa. This implies that the consumer for goods which satisfy
demand curve is downward sloping. their wants directly. They serve direct
consumption needs of the consumers. Thus,
2) Income effect : In the case of normal goods,
it is the demand for consumer goods. For
when price falls, purchasing power (real
example, demand for cloth, sugar, etc.
income) of a consumer increases which
enables him to buy more of that commodity. 2) Indirect demand : Indirect demand is
This is known as income effect. also known as derived demand. It refers
to demand for goods which are needed
3) Substitution effect : In case of substitute
for further production. It is the demand
goods, when the price of a commodity
rises, the consumer tends to buy more of for producer's goods. Hence, all factors of
its substitute and less of that commodity production have indirect or derived demand.
whose price has increased. This is known For example, demand for workers in a sugar
as substitution effect. factory is derived or indirect demand.

19
 3) Complementary/Joint demand : When 2) Income : Income of a consumer decides
two or more goods are demanded jointly to purchasing power which in turn influences
satisfy a single want, it is known as joint or the demand for the product. Rise in income
complementary demand. For example, car will lead to a rise in demand for the
and fuel etc. commodity and a fall in income will lead to
a fall in demand for the commodity.
4) Composite demand : The demand for a
commodity which can be put to several 3) Prices of Substitute Goods : If a substitute
uses is known as composite demand. For good is available at a lower price then
example, electricity is demanded for several people will demand cheaper substitute good
than costly good. For example, if the price
uses such as light, fan, washing machine etc.
of sugar rises then demand for jaggery will
5) Competitive demand : It is demand for rise.
those goods which are substitute for each
4) Price of Complementary Goods : Change
other. For example, tea or coffee, sugar or
in the price of one commodity would also
jaggery etc.
affect the demand for other commodity. For
Try this : example, car and fuel. If the price of fuel
rises, then demand for cars will fall.
Complete the table
5) Nature of product : If a commodity is a
Type of demand Example
necessity and its use is unavoidable, then
Direct demand
its demand will continue to be the same
Workers in cotton textile irrespective of the corresponding price.
industry
For example, medicine to control blood
Joint demand Coffee
Powder pressure.
For 6) Size of population : Larger the size of
preparing population, greater will be the demand
Coffee
for a commodity and smaller the size of
population smaller will be the demand for
CNG and petrol, pen and
a commodity.
pencil
Tea 7) Expectations about future prices : If
Curd the consumer expects the price to fall in
Milk Direct future, he will buy less in the present at the
consumption
Sweets
prevailing price. Similarly, if he expects the
price to rise in future, he will buy more in
the present at the prevailing price.
Determinants of Demand :
The demand for goods is determined by the 8) Advertisement : Advertisement, sales
promotion scheme and effective sales-
following factors :
manship tend to change the preferences
1) Price : Price determines the demand for a of the consumers and lead to demand for
commodity to a large extent. Consumers many products. For example, cosmetics,
prefer to purchase a product in large tooth brush etc.
quantities when price of a product is less and 9) Tastes, Habits and Fashions : Taste and
they purchase a product in small quantities habits of a consumer influence the demand
when price of a product is high. for a commodity. If a consumer likes to
20