D21MBA11764

ASSIGNMENT COVER PAGE

(Theory)
Assignment No: 2
2
Programme Name : MBA Semester: I Credit: 4
Course Title :Managerial Economics Course Code: 21MBA615
Submitted Date: 21 Jan 2022 Last date of Submission: 30 Jan 2022

Max. Marks: 30 Weightage: 15 Marks (50%)

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Page No.

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Assignment No. 2

Programme Name : MBA Semester: ICredit: 4

Course Title :Managerial Economics Course Code:21MBA615

Submitted Date: 21 Jan 2022 Last date of Submission:30 Jan 2022

Max. Marks: 30 Weightage: 15 Marks

Instructions:
 Sec-A is compulsory which consists of Ten Short Answer Questions (1 mark per question).
Answer length should be approximately 100 words.
 Attempt any Five questions from Sec-B out of Seven questions (4 marks per question). Answer
length should be approximately 80 words.

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SECTION-A(10 MARKS)

1. What is meant by opportunity cost principle?

Answer-Economists use the term opportunity cost to indicate what must be given up to obtain
something that’s desired. A fundamental principle of economics is that every choice has an
opportunity cost. If you sleep through your economics class (not recommended, by the way), the
opportunity cost is the learning you miss. If you spend your income on video games, you cannot
spend it on movies. If you choose to marry one person, you give up the opportunity to marry
anyone else. In short, opportunity cost is all around us.
The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or
consume something else; in short, opportunity cost is the value of the next best alternative.
Since people must choose, they inevitably
2.Explain the point of elasticity method.
Answer- Point elasticity shows elasticity at a single point on the demand curve instead of showing
a line. Formula for point of elasticity is by dividing the percent change in quantity demanded by
the percent change in price. An answer greater than 1 means the good is elastic; an answer less
than 1 means the good is inelastic.

4. Draw an indifference curve.

Answer- An indifference curve is a graph showing combination of
two goods that give the consumer equal satisfaction and utility.
Each point on an indifference curve indicates that a consumer is
indifferent between the two and all points give him the same utility
First we will explore the meaning of one particular indifference curve and then we will look at

the indifference curves as a group

Figure shows

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Lilly’s Indifference Curves. Lilly would receive equal utility from all points on a given
indifference curve. Any points on the highest indifference curve Uh, like F, provide greater
utility than any points like A, B, C, and D on the middle indifference curve Um. Similarly, any
points on the middle indifference curve Um provide greater utility than any points on the lowest
indifference curve Ul.

5. Write a note on the law of increasing returns.

Answer- The law of Increasing Returns is also known as the Law of Diminishing
Costs. According to this law when more and more units of variable factors are employed while
other factors are kept constant, there will be an increase of production at a higher rate. This law
is applicable to all different industries and partially applicable in agricultural sector.

Assumptions of the Law

 There is always a scope of improvement in technology and techniques of production.
 At least one factor of production is assumed to be indivisible.
 Some factors are assumed divisible.
Explanation of Law: The law can be explained with the help of the following schedule and
diagram: Schedule:

The schedule shows that the quantity of capital remains the same i.e. 2 machines throughout the
production process but the number of laborers is increased from time to time. The first laborer
has produced a total production (TP) of 10 meters of cloth. After applying the 2nd laborer total
production is increased to 22 meters. The marginal production (MP) of the second laborer is 12,
which goes on increasing. After the use of the 3rd, 4th and then the 5th laborer the total
production is increased from 36 to 70 meters and the M.P from 14 to 18 meters.

6. What is an iso-quant-curve?
Answer- An isoquant (derived from quantity and the Greek word iso, meaning equal),
in microeconomics, is a contour line drawn through the set of points at which the same quantity
of output is produced while changing the quantities of two or more inputs. The x and y axis on an
isoquant represent two relevant inputs, which are usually a factor of production such as labor,
capital, land, or organisation. An isoquant may also be known as an “Iso-Product Curve”, or an
“Equal Product Curve”.

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An isoquant map where production output Q3 > Q2 > Q1. Typically inputs X and Y would refer
to labor and capital respectively. More of input X, input Y, or both is required to move from
isoquant Q1 to Q2, or from Q2 to Q3.

A) Example of an isoquant map with two inputs that are perfect substitutes.

B) Example of an isoquant map with two inputs that are perfect complements.

7. Indicate the main features of the LAC curve.

Answer- The long-run cost curve is a part of macroeconomics which deals with the production
and size of a plant in an organisation. This section speaks of the variables and factors which
affect the curve of the production and cost in the long run. It is important to note that there is no
difference between the Long-run total costs, and the long-run cost is variable. It depends on the
ability of a firm and its changing inputs at a lower price.

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Long-run Average Cost (LAC) is the total cost divided by any level of output. It is ideally
derived by long-run average price from short-run average cost curve. In the short-run turn, a firm
or plant remains fixed, and the curve corresponds to a respective plant. Here the long average
cost curve is termed as planning or envelope curve due to its function in preparing plans for
enlarging production at a minimum cost.
A good example will be taking three sizes of plants where nothing else can be built. In the short-
run curve, this plant size remains fixed, which can increase or decrease the variables. However,
in the long term, a firm has the flexibility to choose the options of plants which can aid in the
highest output at minimum cost.

8. What do you mean by the term “market” in economics?

Answer- A market is a place where parties can gather to facilitate the exchange of goods and
services. The parties involved are usually buyers and sellers. The market may be physical like a
retail outlet, where people meet face-to-face, or virtual like an online market, where there is no
direct physical contact between buyers and sellers.
A market is a place where buyers and sellers can meet to facilitate the exchange or transaction of
goods and services.
Markets can be physical like a retail outlet, or virtual like an e-retailer.
Other examples include the illegal markets, auction markets, and financial markets.
Markets establish the prices of goods and services that are determined by supply and demand

9. Define National Income.

Answer- :- National income means the value of goods and services produced by a country during
a financial year. Thus, it is the net result of all economic activities of any country during a period
of one year and is valued in terms of money. National income is an uncertain term and is often
used interchangeably with the national dividend, national output, and national expenditure. We
can understand this concept by understanding the national income definition.
There are two National Income Definition
 Traditional Definition
 Modern Definition
According to Marshall: “The labor and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material and immaterial
including services of all kinds. This is the true net annual income or revenue of the country or
national dividend.”
Simon Kuznets defines national income as “the net output of commodities and services flowing
during the year from the country’s productive system in the hands of the ultimate consumers.”

10. Define the term 'Macro Economics'.

Answer-Macroeconomics is a branch of economics that studies how an overall economy—the
market or other systems that operate on a large scale—behaves. Macroeconomics studies
economy-wide phenomena such as inflation, price levels, rate of economic growth, national
income, gross domestic product (GDP), and changes in unemployment.

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Macroeconomics deals with the performance, structure, and behaviour of the entire economy, in
contrast to microeconomics, which is more focused on the choices made by individual actors in
the economy (like people, households, industries, etc.

Macroeconomics is the branch of economics that deals with the structure, performance,
behaviour, and decision-making of the whole, or aggregate, economy.
The two main areas of macroeconomic research are long-term economic growth and shorter-term
business cycles.
Macroeconomics in its modern form is often defined as starting with John Maynard Keynes and
his theories about market behavior and governmental policies in the 1930s; several schools of
thought have developed since.
In contrast to macroeconomics, microeconomics is more focused on the influences on and
choices made by individual actors in the economy (people, companies, industries, etc.

11. What is propensity to consume?

Answer-In economics, the marginal propensity to consume (MPC) is a metric that
quantifies induced consumption, the concept that the increase in personal consumer spending
(consumption) occurs with an increase in disposable income (income after taxes and transfers).
The proportion of disposable income which individuals spend on consumption is known as
propensity to consume. MPC is the proportion of additional income that an individual consumes.
For example, if a household earns one extra dollar of disposable income, and the marginal
propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35
cents. Obviously, the household cannot spend more than the extra dollar (without borrowing).
According to John Maynard Keynes, marginal propensity to consume is less than one
[1] Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New
York: Harcourt Brace Jovanovich. p. 96. The fundamental psychological law ... is that men [and
women] are disposed, as a rule and on average, to increase their consumption as their income
increases, but not asmuch as the increase in their income.

Section –B(20 Marks)

1. Explain increase and decrease in demand.

Answer-  Determinants of demand other than price such as consumers’ tastes and preferences,
income, price of the related goods change, the whole demand curve will change. When due to the
changes in these other factors, the demand curve shifts upwards, increase in demand is said to
have occurred.
Increase in demand means the consumer buys more of the good at various prices than before. For
example, if the income of a consumer increases, or if the fashion for a goods increases, the
consumer will buy greater quantities of the goods than before at various given prices. As a result
the whole demand curve will shift upward, flow considers Figure 7.

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In the beginning, the demand curve is DD. If there is a favorable change in the factors
determining the demand and the demand curve for the goods shift upward to D’D’, increase in
demand has occurred. It will be clear from the Figure 7. that when the demand curve for the
goods is DD, then the price OF, OM quantity of the goods is demanded, but with the demand
curve D’D’, at the same price OP, a greater quantity OH is demanded.Likewise, at other prices
also, at the demand curve D’D’, more quantity is demanded than at the demand curve DD. We
have explained above how the increase in demand takes place.

increase in demand occurs due to the following reasons:-

(i) The fashion for a goods increases or people’s tastes and preferences become more favourable
for the good;

(ii) Consumer’s income increases.

(iii) Prices of the substitutes of the goods in question have risen.

(iv) Prices of complementary goods have fallen.

(v) Propensity to consume of the people has increased and

(vi) Owing to the increase in population and as a result of expansion in market, the number of
consumers of the goods has increased.

If there is any above change, demand will increase and the demand curve will shift to an upward
position.Now, take the question of decrease in demand. Whereas the contraction in demand
implies the fall in quantity demanded as a result of rise in price, decrease in demand means the
whole demand curve shifts to a lower position. In other words, decrease in demand means that at

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various prices, less is demanded than before. The decrease in demand does not occur due to the
rise in price but due to the changes in other determinants of demand.

Decrease in demand may occur due to the following reasons:

(i) A goods has gone out of fashion or the tastes of the people for a commodity have declined.

(ii) Incomes of the consumers have fallen.

(iii) The prices of the substitutes of the commodity have fallen.

(iv) The prices of the complements of that commodity have risen and

(v) The propensity to consume of the people has declined. In other words, the propensity to save
has increased.

Increase and decrease in demand is depicted in Figure 7. In this figure DD is the demand curve
for the goods in the beginning. If due to the above reasons the demand for the goods declines, the
whole demand curve will shift below. In figure 7 as a result of the decrease in demand, demand
curve has shifted below to the position D”D”.

It is now clear from the figure that when the demand curve shifts below from DD to D”D”, at
price OP, quantity demanded decreases from OM to OL. A glance at the demand curve D”D”
will reveal that at prices other than Op also, less quantity of the good is demanded at the demand
curve D”D” than at the demand curve DD.

2. Describe in detail the various methods of measuring elasticity of demand.

Answer-There are four methods of measuring elasticity of demand. They are the percentage
method, point method, arc method and expenditure method.

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(1) The Percentage Method:

The price elasticity of demand is measured by its coefficient Ep. This coefficient Ep measures
the percentage change in the quantity of a commodity demanded resulting from a given
percentage change in its price: Thus

Where q refers to quantity demanded, p to price and ∆ to change. If Ep> 1, demand is elastic. If
Ep < 1, demand is inelastic, it Ep = 1 demand is unitary elastic.

Combination Price (Rs.) Quantity Kgs.

per Kg. of of X
X

A 6 0

В 5 ————-► 10

С 4 20

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D 3 ————-► 30

E 2 40

F 1 ————► 50

G 0 60

Let us first take combinations В and D.

(i) Suppose the price of commodity X falls from Rs. 5 per kg. to Rs. 3 per kg. and its quantity
demanded increases from 10 kgs. to 30 kgs. Then

This shows elastic demand or elasticity of demand greater than unitary.

Note: The formula can be understood like this:
∆q =q2 –q1 where <72 is the new quantity (30 kgs.) and q1 the original quantity (10 kgs.)
∆p – p2– P1 where p2 is the new price (Rs. 3) and <$Ep sub 1> the original price (Rs. 5)
:
In the formula, p refers to the original price (p,) and q to original quantity (q1). The opposite is
the case in example (ii) below, where Rs. 3 becomes the original price and 30 kgs. as the original
quantity.
(ii) Let us measure elasticity by moving in the reverse direction. Suppose the price of X rises
from Rs. 3 per kg. to Rs. 5 per kg. and the quantity demanded decreases from 30 kgs. to 10 kgs.
Then

This shows unitary elasticity of demand.

:
Notice that the value of Ep in example (ii) differs from that in example (i) depending on the
direction in which we move. This difference in the elasticities is due to the use of a different base
in computing percentage changes in each case.
Now consider combinations D and F.
(iii) Suppose the price of commodity X falls from Rs. 3 per kg. to Re. 1 per kg. and its quantity
demanded increases from 30 kgs. to 50 kgs. Then

This is again unitary elasticity.

:
(iv) Take the reverse order when the price rises from Re. 1 per kg. to Rs. 3 per kg. and the
quantity demanded decreases from 50 kgs. to 30 kgs. Then

This shows inelastic demand or less than unitary.

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:
The value of Ep again differs in this example than that given in example (iii) for the reason stated
above.
(2) The Point Method:
Prof. Marshall devised a geometrical method for measuring elasticity at a point on the demand
curve. Let RS be a straight line demand curve in Figure 11.2. If the price falls from PB(=OA) to
MD(=OC). the quantity demanded increases from OB to OD. Elasticity at point P on the RS
demand curve according to the formula is: Ep = ∆q/∆p x p/q

Where ∆ q represents changes in quantity demanded, ∆p changes in price level while p and q are
initial price and quantity levels.
From Figure 11.2
∆ q = BD = QM
ADVERTISEMENTS:
∆p = PQ
p = PB
q = OB
Substituting these values in the elasticity formula:

With the help of the point method, it is easy to point out the elasticity at any point along a
demand curve. Suppose that the straight line demand curve DC in Figure 11.3 is 6 centimetres.

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Five points L, M, N, P and Q are taken oh this demand curve. The elasticity of demand at each
point can be known with the help of the above method. Let point N be in the middle of the
demand curve. So elasticity of demand at point.

We arrive at the conclusion that at the mid-point on the demand curve the elasticity of demand is
unity. Moving up the demand curve from the mid-point, elasticity becomes greater. When the
demand curve touches the Y-axis, elasticity is infinity. Ipso facto, any point below the mid-point
towards the X-axis will show elastic demand.
Elasticity becomes zero when the demand curve touches the X-axis.
(3) The Arc Method:
We have studied the measurement of elasticity at a point on a demand curve. But when elasticity
is measured between two points on the same demand curve, it is known as arc elasticity. In the
words of Prof. Baumol, “Arc elasticity is a measure of the average responsiveness to price
change exhibited by a demand curve over some finite stretch of the curve.”
Any two points on a demand curve make an arc. The area between P and M on the DD curve in
Figure 11.4 is an arc which measures elasticity over a certain range of price and quantities. On
any two points of a demand curve the elasticity coefficients are likely to be different depending
upon the method of computation. Consider the price-quantity combinations P and M as given in
Table 11.2.

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Table 11.2: Demand Schedule:

Point Price (Rs.) Quantity (Kg)

P 8 10

M 6 12

If we move from P to M, the elasticity of demand is:

If we move in the reverse direction from M to P, then

Thus the point method of measuring elasticity at two points on a demand curve gives different
elasticity coefficients because we used a different base in computing the percentage change in
each case.
To avoid this discrepancy, elasticity for the arc (PM in Figure 11.4) is calculated by taking the
average of the two prices [(p1, + p2 1/2] and the average of the two quantities [(p1, + q2) 1/2].
The formula for price elasticity of demand at the mid-point (C in Figure 11.4) of the arc on the
demand curve is

On the basis of this formula, we can measure arc elasticity of demand when there is a movement
either from point P to M or from M to P.
From P to M at P, p1 = 8, q1, =10, and at M, P2 = 6, q2 = 12
Applying these values, we get

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Thus whether we move from M to P or P to M on the arc PM of the DD curve, the formula for
arc elasticity of demand gives the same numerical value. The closer the two points P and M are,
the more accurate is the measure of elasticity on the basis of this formula. If the two points which
form the arc on the demand curve are so close that they almost merge into each other, the
numerical value of arc elasticity equals the numerical value of point elasticity.
(4) The Total Outlay Method:
Marshall evolved the total outlay, total revenue or total expenditure method as a measure of
elasticity. By comparing the total expenditure of a purchaser both before and after the change in
price, it can be known whether his demand for a good is elastic, unity or less elastic. Total outlay
is price multiplied by the quantity of a good purchased: Total Outlay = Price x Quantity
Demanded. This is explained with the help of the demand schedule in Table 11.3.
:
(i) Elastic Demand:
Demand is elastic, when with the fall in price the total expenditure increases and with the rise in
price the total expenditure decreases. Table 11.3 shows that when the price falls from Rs. 9 to
Rs. 8, the total expenditure increases from Rs. 180 to Rs. 240 and when price rises from Rs. 7 to
Rs. 8, the total expenditure falls from Rs. 280 to Rs. 240. Demand is elastic (Ep > 1) in this case.

(ii) Unitary Elastic Demand:

When with the fall or rise in price, the total expenditure remains unchanged; the elasticity of
demand is unity. This is shown in the Table when with the fall in price from Rs. 6 to Rs. 5 or
with the rise in price from Rs. 4 to Rs. 5, the total expenditure remains unchanged at Rs. 300,
i.e., Ep = 1.
(iii) Less Elastic Demand:
Demand is less elastic if with the fall in price the total expenditure falls and with the rise in price
the total expenditure rises. In the Table when the price falls from Rs. 3 to Rs. 2 total expenditure
falls from Rs. 240 to Rs. 180, and when the price rises from Re. 1 to Rs. 2 the total expenditure
also rises from Rs. 100 to Rs. 180. This is the case of inelastic or less elastic demand, Ep < 1.
Table 11.4 summarises these relationships:

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Table 11.4: Total Outlay Method:

Price ТЕ Ep

Falls Rises >> 1

Rises Falls

Falls Unchanged =1

Rises Unchanged

Falls Falls

Rises Rises << 1

Figure 11.5 illustrates the relation between elasticity of demand and total expenditure. The
rectangles show total expenditure: Price x quantity demanded. The figure shows that at the
midpoint of the demand curve, total expenditure is maximum in the range of unitary elasticity,
i.e. Rs. 6, Rs. 5 and Rs. 4 with quantities 50 kgs., 60 kgs. and 75 kgs.

Total expenditure rises as price falls, in the elastic range of demand, i.e. Rs. 9, Rs. 8 and Rs. 7
with quantities 20 kgs., 30 kgs. and 40 kgs. Total expenditure falls as price falls in the elasticity
range, i.e. Rs.3, Rs. 2 and Re. 1 with quantities 80 kgs., 90 kgs. and 100 kgs. Thus elasticity of
demand is unitary in the AB range of DD, curve, elastic in the range AD above point A and less
elastic in the BD1 range below point B. The conclusion is that price elasticity of demand refers
to a movement along a specific demand curve.

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3. State and explain the law of diminishing marginal utility.

Answer- :- In economics, diminishing returns is the decrease in marginal (incremental) output
of a production process as the amount of a single factor of production is incrementally increased,
holding all other factors of production equal (ceteris paribus The law of diminishing returns (also
known as the law of diminishing marginal productivity) states that in productive processes,
increasing a factor of production by one unit, while holding all others production factors
constant, will at some point return a lower unit of output per incremental unit of input [3] The
law of diminishing returns does not cause a decrease in overall production capabilities, rather it
defines a point on a production curve whereby producing an additional unit of output will result
in a loss and is known as negative returns. Under diminishing returns, output remains positive
however productivity and efficiency decrease.
The modern understanding of the law adds the dimension of holding other outputs equal, since a
given process is understood to be able to produce co-products an example would be a factory
increasing its saleable product, but also increasing its CO2 production, for the same input
increase.  The law of diminishing returns is a fundamental principle of both micro and macro
economics and it plays a central role in production theory.
The concept of diminishing returns can be explained by considering other theories such as the
concept of exponential growth It is commonly understood that growth will not continue to rise
exponentially, rather it is subject to different forms of constraints such as limited availability of
resources and capitalisation which can cause economic stagnation. This example of production
holds true to this common understanding as production is subject to the four factors of
production which are land, labour, capital and enterprise. These factors have the ability to
influence economic growth and can eventually limit or inhibit continuous exponential
growth Therefore, as a result of these constraints the production process will eventually reach a
point of maximum yield on the production curve and this is where marginal output will stagnate
and move towards zero.  However it should also be considered that innovation in the form of
technological advances or managerial progress can minimise or eliminate diminishing returns to
restore productivity and efficiency, and to generate profit.

Diminishing Returns Graph The graph highlights the concept of diminishing returns by plotting
the curve of output against input. The areas of increasing, diminishing and negative returns are
identified at points along the curve. There is also a point of maximum yield which is the point on
the curve where producing another unit of output becomes inefficient and unproductive.
This idea can be understood outside of economics theory, for example, population. The
population size on Earth is growing rapidly, but this will not continue forever (exponentially).
Constraints such as resources will see the population growth stagnate at some point and begin to

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decline Similarly, it will begin to decline towards zero, but not actually become a negative value.
The same idea as in the diminishing rate of return inevitable to the production process.

Figure 2: Output vs. Input [top] & Output per unit Input vs. Input [bottom] Seen in [top], the
change in output by increasing output from L1 to L2 is equal to the change from L2 to L3. Seen
in [bottom], until an output of L1, the output per unit is increasing. After L1, the output per unit
decreases to zero at L3. Together, these demonstrate diminishing returns from L1.
Assumptions
There is short run in the market during which fixed factors of production cannot be changed.
Labour is the only variable factor while other factors are assumed constant.
All units of variable factors are homogeneous and equally efficient.
There is no change in the state of technology and techniques of production.
The reward of the factors of production should remain constant.
Explanation
The law can be explained with the help of the following schedule and diagram.

The Schedule shows that if one unit of labour is applied on 12 acres of land (which is fixed), it
will produce 20 mounds of wheat. When two units of labour are applied on the same quantity of
land, the total production will increase to 45 mounds. Thus marginal production (MP) of the
second variable factor is 25 mounds. It is clear that the given quantity of land cannot be fully
utilized by applying only one labour. Thus the units of labour are increased again and again. The
optimum level is achieved when the 6th unit is applied at which MP of labour is Zero and TP is
Maximum. After the optimum level the additional unit of labour results in negative marginal
production and decline in TP.

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In the Law of diminishing return graph the units of labour are measured along X-axis while the
Total and Marginal production is measured along Y-axis. The total production (TP) curve is
represented by NRS while NUL represents the, Marginal Production (MP) Curve
4. State and explain the law of equi-marginal utility.
Answer-Law of Equi-Marginal Utility explains the relation between the consumption of two or
more products and what combination of consumption these products will give optimum
satisfaction. Marginal Utility is the additional satisfaction gained by consuming one more unit of
a commodity. Let’s try and understand
Assumptions of Law of Equi-Marginal Utility
 Units of goods are homogenous.
 No time gap between the consumption of the different units.
 Tastes, fashion, preferences, and priorities remain unchanged.
 Consumer aims at maximum satisfaction.
 Consumer’s income is fixed and limited.
Types of Marginal Utility
Based on the relationship between the total and the Marginal Utility, there are three types of
marginal utility.
Positive
The marginal utility is positive when the consumption of an additional unit of a product results in
the increase in the total utility. Getting a coupon of free hair spa is its example.
Negative
It is negative when the consumption of an additional unit of a product results in the decrease in
the total utility. Taking more vitamin supplements or overtake of some medicine is its example.
Zero
It is zero when the consumption of an additional unit of a product results in no change in the total
utility. Getting two copies of the same novel is one of the examples of zero marginal utility.
Suppose we have data for the marginal and the total utility for different units of ice creams. Let
us see the relation between the two.

Units Total Utility Marginal Utility

1 20 20

2 35 15

3 45 10

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4 52 7

5 55 3

6 55 0

7 52 -2

8 47 -5

9 36 -11

10 20 -16

This law is based on the principle of obtaining maximum satisfaction from a limited income. It
explains the behavior of a consumer when he consumes more than one commodity.
The law states that a consumer should spend his limited income on different commodities in such
a way that the last rupee spent on each commodity yield him equal marginal utility in order to get
maximum satisfaction.
Suppose there are different commodities like A, B, …, N. A consumer will get the maximum
satisfaction in the case of equilibrium i.e.,
MUA / PA = MUB / PB = … = MUN / PN

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Where MU’s are the marginal utilities for the commodities and P’s are the prices of the
commodities.
 
Assumptions of the Law
 There is no change in the price of the goods or services.
 The consumer has a fixed income.
 The marginal utility of money is constant.
 A consumer has perfect knowledge of utility.
 Consumer tries to have maximum satisfaction.
 The utility is measurable in cardinal terms.
 There are substitutes for goods.
 A consumer has many wants.
Limitation of the Law
 There are some limitations to this law. They are
 The law is not applicable in case of knowledge. Reading books provides more knowledge
and has more utility.
 This law is not applicable in case of fashion and customs.
 This law is not applicable for very low income.
 There is no measurement of utility.
 Not all consumer care for variety.
 The law fails when there are no choices available for the good.
 The law fails in case of frequent price change.
Importance of the Law
This law is helpful in the field of production. A producer has limited resources and tries to get
maximum profit.
This law is helpful in the field of exchange. The exchange is of anything like some goods,
wealth, trade, import, and export.
It is applicable to public finance.
The law is useful for workers in allocating the time between the work and rest.
It is useful in case of saving and spending.
It is useful to look for substitution in case of price rise.

5. Briefly explain ordinal measurement of utility.

Answer- Ordinal measurement of utility refers to the measurement (or expression) of utility in terms
ranks like high or low (more or less). Ordinality means that utility can be ranked based on consumer
preferences.
In economics, an ordinal utility function is a function representing the preferences of an agent on
an ordinal scale. Ordinal utility theory claims that it is only meaningful to ask which option is
better than the other, but it is meaningless to ask how much better it is or how good it is. All of
the theory of consumer decision-making under conditions of certainty can be, and typically is,
expressed in terms of ordinal utility.
For example, suppose George tells us that "I prefer A to B and B to C". George's preferences can
be represented by a function u such that:

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{\displaystyleu(A)=9,u(B)=8,u(C)=1}
But critics of cardinal utility claim the only meaningful message of this function is the order {\

displaystyle u(A)>u(B)>u(C)} ; the actual numbers are meaningless. Hence, George's

preferences can also be represented by the following function v:

{\displaystylev(A)=9,v(B)=2,v(C)=1}
The functions u and v are ordinally equivalent – they represent George's preferences equally
well.
Ordinal utility contrasts with cardinal utility theory: the latter assumes that the differences
between preferences are also important. In u the difference between A and B is much smaller
than between B and C, while in v the opposite is true. Hence, u and v are not cardinally
equivalent.
The ordinal utility concept was first introduced by Pareto in 1906
Cardinal vs. Marginal Utility
In economics, utility simply means the satisfaction that a consumer experiences from a product
or service. While the concept is considered an important factor in decision-making and product
choice, it presents a problem for economists trying to incorporate the concept
to microeconomics models because utility varies among consumers for the same product, and it
can be influenced by other factors, such as price and the availability of alternatives.
KEY TAKEAWAYS
Utility measures the amount of satisfaction that an individual receives from a product or service.
Utility comes in two types: cardinal and marginal.
Cardinal utility assigns a number to the utility, such as a basket of apples gives a utility of 10 and
a bushel of corn is 20.
Marginal utility is based on the idea utility functions diminish as quantities of products are
increased.
Cardinal utility is an attempt to quantify and abstract concept because it assigns a numerical
value to utility. Models that incorporate cardinal utility use the theoretical unit of utility, the util,
in the same way that any other measurable quantity is used. For example, a basket of bananas
might give a consumer a utility of 10, while a basket of mangoes might give a utility of 20.
The downside to cardinal utility is that there is no fixed scale to work from. The idea of 10 utils
is meaningless in and of itself, and the factors that influence the number might vary widely from
one consumer to the next. If another consumer gives bananas a util value of 15, it doesn't
necessarily mean that the individual likes bananas 50% than the first consumer. The implication
is that there is no way to compare utility between consumers.
One important concept related to cardinal utility is the law of diminishing marginal utility, which
states that at a certain point, every extra unit of a good provides less and less utility. While a
consumer might assign the first basket of bananas a value of 10 utils, after several baskets, the
additional utility of each new basket might decline significantly. The values that are assigned to
each additional basket can be used to find the point at which utility is maximized or to estimate a
customer's demand curve
An alternative way to measure utility is the concept of ordinal utility, which uses rankings
instead of values. The benefit of using rankings is that the subjective differences between
products and between consumers are eliminated, and all that remains are the ranked preferences.
One consumer might like mangoes more than bananas, and another might prefer bananas over

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mangoes. These are comparable, if subjective preferences.Lastly, utility is used in the

development of indifference curves, which represent the combination of two products that a
consumer values equally and independently of price. For example, a consumer might be equally
happy with three bananas and one mango or one banana and two mangoes. As a result, three
bananas plus one mango and one banana plus two mangoes represent two points on the
consumer's indifference curve.

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