when he is purchasing more than one good. Law of Demand and the Derivation of the Demand Curve: Using the principle of additive utility, Marshall derived the law of demand and the demand curve. Assuming that the income of the consumer, his preferences and the price of one good remain the same, we can derive that as the price of a good falls, the demand for it will increase. When the price of good A falls, other things being the same, the MU A /P A will be greater than MU B /P B and MU m . In such a case, marginal utility of A must be reduced. Therefore, the consumer has to buy more units of the good whose price has decreased. The proportionality rule requires that as the price of a goods falls, the quantity demanded of that good has to increase. In figure 4.1 we show the derivation of the demand curve. The upper plane (Panel A) shows the equilibrium of the consumer. Given his money income, OX is the marginal utility of money, MUm. As the price of A falls, the MUA/PA will shift from MUA/PA1 to MUA/PA2 and to MUA/PA3. The consumer will increase his purchase of good A to maintain a constant marginal utility of money. The lower panel (Panel B) shows the derivation of the demand curve. As the price of A falls from P1 to P2 and to P3, the consumer increases his purchases from qA1 to qA2 and qA3. Thus, a fall in the price of a good, results in larger demand, ceteris paribus .
Limitations of Cardinal Utility Analysis: Following are some of the limitations of the Marshall’s cardinal approach to utility: 1. As utility is a psychological concept and hence subjective, it is not possible to measure utility objectively in quantitative terms. A consumer can only say whether the satisfaction derived from the consumption of different goods gave more or less satisfaction and will never be able to quantify the utility. 2. Marshall assumed that the utility is independent of the utility of other goods consumed. However, given the money income, utility of any one goods is linked to the utility of other goods that are used by the consumers. Moreover, some goods are complementary while others are substitutes. Hence, the utility derived from any one good is invariably linked to the utility of other goods consumed. 3. The assumption of constant marginal utility of money is also not valid. As the consumer spends money on one good, the money left with him/her reduces. Therefore, the marginal utility of the remaining money income increases instead of remaining constant. Further, as the price of a good changes the real income of the consumer also changes. With the change in real income, the marginal utility of money also changes. This would have an effect on the demand for the good that is being studied as well as on the demand for other goods as well. Therefore, the assumption of constant marginal utility of money is both conceptually and practically untenable. If the marginal utility of money changes we cannot use it to measure utility objectively.
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- Fall '16
- anjali bansal
- Economics, Consumer