# Merchant of Venice

1 January 2017

Also use this law to explain the law of demand; l explain the concept of consumer’s surplus; l explain consumer’s behaviour in terms of ordinal utility theory, the Hicks-Allen approach l describe consumer’s equilibrium condition in terms of ordinal utility theory; l decompose price effect into substitution effect and income effect; l graphically derive price consumption curve and income consumption curve, and demand curve for a good; l understand the difference between normal, inferior, and Giffen goods; l provide a comparative evaluation of the two competing theories.

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In the previous unit we have introduced the concept of demand function, various determinants of demand and its elasticity. In this unit, we continue the discussion on demand and focus our attention on consumer’s behaviour in order to explain the law of demand. The law of demand says that when price of a commodity is lowered a larger quantity is demanded, and when price rises a smaller quantity is demanded, other things remaining the same. In other words, the law states that price and quantity demanded are inversely related. In this unit we will introduce you two contending theories – Alfred Marshall’s cardinal utility theory of demand, and J.

R. Hick’s and R. G. D. Allen’s preference approach (or the indifference curve theory, or the ordinal utility theory) of consumer behaviour. In Hicks-Allen approach some of the restrictive assumptions of the Marshallian approach are dropped. Particularly, that utility is a cardinal concept and is measurable on a numerical scale with an absolute zero and that marginal utility of money is constant are relaxed. Marshallian theory is also based on the law of diminishing marginal utility as well as on inter-personal comparisons of utility.

Defined as additional utility per additional unit of the commodity consumed. It measures the change in total utility resulting from an extra unit of consumption of a commodity. Marginal Rate of : It is the psychological rate of substitution between any Substitution (MRS) pair of goods defined on a given indifference curve. In other words, how much of one good the consumer must give up per unit of the other good acquired so that the consumer remains on an indifference curve. It is something, which the consumer works in her mind. Normal Good : When consumption of good changes in the same irection as income changes it is called a normal good. Ordinal : The numbers used to represent an ordering like 1st, 2nd and 3rd. Price Effect : The change in consumption of a good when price of good changes with money income and price of the other good held constant. Price-Consumption

The curve that shows how consumption changes when Curve price of a good changes with everything else unchanged including money income, prices of all other goods and the consumer’s taste. Substitution Effect : The effect on consumption of a good when relative price of good changes with money income adjusted to hold eal income constant. Mathematically, the sign of substitution effect is always negative. Total Utility : The total satisfaction derived from consumption, which will be the sum of marginal utilities. Utility : is defined as a want satisfying power of a commodity. It is the subjective sensation, which an individual derives from consuming a commodity. If such a sensation can be measured quantitatively on a numerical scale we call it cardinal utility. Content : EEC11 No comments: Post a Comment Related Web Create a Link Newer PostOlder PostHome Subscribe to: Post Comments (Atom) | | Simple template. Powered by Blogger.

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