Unit 2

DEMAND AND REVENUE

ANALYSIS
 Introduction
Central theme of the managerial economics beginning with
the analysis of consumer behavior and the theory of demand.
Consumer demand is the basis of all productive activities.
Just as ‘ necessity is the mother of invention ‘
Demand is the mother of production
Increasing demand – high business prospects
Decreasing demand – diminishes business prospects
Example ?
It is therefore essential for business managers to have a clear
understanding of the following aspects of demand for their
products :
1) What is the basis of demand for a commodity?
2) What are the determinants of demand?
3) How do buyers decide the quantity of a product to be
purchased?
4) How do the buyers respond to change in product
prices, their incomes and prices of the related goods?
5) How can the total or market demand for a product be
assessed and forecasted?
Theses questions are answered by the analysis of
consumer behaviour. The study of consumer behaviour
give rise to the “THEROY OF CONSUMER DEMAND”
 Meaning of DEMAND
The concept demand refers to the quantity of a good or
service that consumer are willing and able to purchase at
various prices during a period of time
In economics demand is:
EFFECTIVE DEMAND = DESIRE + ABILITY TO PURCHASE +
WILLINGNESS TO PURCHASE
QUANTITY DEMANDED

IT IS ALWAYS EXPRESSED IT IS A FLOW (TIME

AT GIVEN PRICE PERIOD)

Example: a) 10 kg of sugar
b) 10 kg of sugar per month
c) 10 kg of sugar per month at Rs 15/- per kg
Basis of consumer demand:
THE UTILTIY
 Utility
• Utility is the quality in goods to satisfy human wants. Thus it
is said that “Wants Satisfying capacity of goods and services
is called Utility”
• In terms of economics consumer demands only those
products which have utility to satisfy his wants.

a) Capacity of commodity to satisfy human wants

b) Want satisfying power of the commodity

Example: He demands food, shelter, entertainment to satisfy

his wants like hunger, fun and to shelter to live life comfortably.
 UTILTIY

Features
1) Utility is subjective
2) Utility and usefulness are not same
3) Utility is ethically neutral
4) Utility and satisfaction are not same
5) Utility can be cardinally measured
6) Utility and pleasure are different
Utility hypothesis forms the basis for the theory of consumer behaviour

Marginal utility Indifference curve

analysis analysis

Dr. Marshall
Hicks and Allen

Quantitative Non quantitative

concept/cardinal concept /ordinal
approach approach
Approach Cardinal approach Ordinal approach

Assumption Utility is a measurable and Utility is not quantifiable i.e.

quantifiable aspect, i.e. can be cannot be expressed in terms
expressed in numbers of numbers

Rationale Human satisfaction can be Human satisfaction is a

expressed in monetary terms, psychological concept and
and the price of a commodity cannot be measured
in the market indicates the quantitatively in monetary
customers level of satisfaction terms
i.e. he is ready to pay that
price

Theories Law of diminishing marginal Indifference curve approach

utility based on relative preferences
Law of Equi Marginal utility of customers
 TYPES OF UTILITY
1) FORM UTILITY
2) PLACE UTILITY
3) TIME UTILITY
4) SERVICE UTILITY
5) KNOWLEDGE UTILTIY
Cardinal approach: Marginal utility analysis

QUANTITATIVE CONCEPTS OF UTILTIY

Total utility: It is sum total of the utility derived from
different units of a commodity consumed by a
consumer
TUn = U1 + U2 + U3 …..Un
TOTAL UTILITY IS SUMMATION OF MARGINAL UTILITES
It can be calculated as:
• TUn=MU1+MU2+............................MUn
• TU= summation of MUs
Marginal utility: it is additional utility derived from
additional unit of a commodity
MUn = ^ TUn / ^Q
change in total utility / change in quantity of
units consumed

Marginal Utility(MU) can also be calculated as:

MUn=TUn-TUn-1
Where, MUn= Marginal utility from nth unit, TUn= total
utility from n units
TUn-1= Total utility from n-1 units, n= Number of units
Ice creams Marginal utility Total utility
consumed

1 20 20

2 16 36

3 10 46

4 4 50

5 0 50

6 -6 44
 Total utility
60

50 50 50

46
44

40

36
TOTAL UTILITY

30 Total utility

20 20

10

0
1 2 3 4 5 6

units consumed of ice cream

 Marginal utility
25

20 20

16
15
marginal utility

10 10
Marginal utility

5
4

0 0
1 2 3 4 5 6

-5
-6

-10

units consumed og Ice cream

LAW OF DIMINISHING MARGINAL
UTILITY
 Assumptions of the law
1) Homogeneity
2) Cardinal measurement
3) Constant marginal utility of money
4) Continuous consumption
5) Standard units
6) Independence of utilities
7) Single want
8) Condition of divisibility
9) Rationality
Law of diminishing marginal utility
Law:
a) The additional benefit (marginal utility) which a person derives from
a given increase in stock of a thing diminishes with every increase in
the stock that he already has.
b) As a consumer takes more units of an item, the extra satisfaction
(Marginal utility) that he derives from an extra unit, declines with the
increase in the consumption of the item.
Explanation:
a) Even though the total wants of a person are virtually unlimited, each
single want is satiable
b) Since each want is satiable, as a consumer consumes more and more
units of an item , the intensity of his want for the item goes on
decreasing and a point is reached where the consumer no longer
wants it
Ice creams Marginal utility Total utility
consumed
1 20 20

2 16 36

3 10 46

4 4 50

5 0 50

6 -6 44
 Total utility
60

50 50 50
46
44
40
36

TOTAL UTILITY 30 Total utility

20 20

10

0
1 2 3 4 5 6
units consumed of ice cream

25
Marginal utility
20 20

15 16
marginal utility

10 10
Marginal utility
5 4
0 0
1 2 3 4 5 6
-5 -6
-10
units consumed og Ice cream
. Initially total utility and marginal utility are equal i.e.
TU=MU
From the consumption of second ice cream, total utility
increases at diminishing (slow) rate and marginal utility
goes on decreasing. So TU curve slopes upwards and MU
curve slopes downwards
After consuming 5th ice cream, total utility is maximum,
marginal utility is zero. It indicates point of satiety
(Maximum satisfaction). At this point , TU curve reaches
highest level and MU curve touches X axis (TU maximum,
MU zero)
After consuming 6th ice cream, the total utility declines,
marginal utility intersects the ‘X’ axis and becomes
negative. It shows dissatisfaction of consumers, it is also
known as disutility. In this case, TU curve starts falling
and MU curve* enter into the negative quadrant
It is observed that total utility is always positive but
marginal utility may be positive, zero or even negative
 Exceptions of the law
1) Hobbies
2) Misers
3) Drunkards
4) Music
5) Power
6) Money
 Limitations
a) Unrealistic assumptions
b) Cardinal measurement
c) Indivisible goods
d) Constant marginal utility of money
e) A single want