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Chp 15 :Neoclassical School- Alfred Marshall (Utility and Demand (2…
Chp 15 :Neoclassical School- Alfred Marshall
Utility and Demand
MU diminishes as the
amount increase
2 important qualifications
He pointed out that he was concerned with
moment of time
which is -
too short a time an interval
will not lead to
changes in character and taste of person
Consumer goods that are
indivisible
. Small quantity of commodity may be
insufficient to meet certain special want
, there will be more than
proportionate increase
of pleasure when consumer gets enough to meet desirable end.
Demand is based on the
law of diminishing MU
He suggested money could be used to
measure utility of intangibles
Money measure utility
at the margin-the point at which decision are made
Price of money has
greater MU to poor person
than rich person bcs poor person has
less mony initially
Pure Neoclassical
Rational Consumer Choice
Decision to spend will be done by
weighing the MU of 2 different types of expenditures
Marshall successfully tied this equimarginal rule directly to the
contemporary law of demand
His demand analysis used idea of rational consumer choice
Law of Demand
The amount
demanded increase with a fall in price
, and diminishes with rise in price
Suppose
MUx/Px =MUy/Py..=MUn/Pn
. If price of X decline,ratio of
MUx/Px > MU/P
of all other goods
His law of demand follows directly his
notion of DMU
and
rational consumer choice
As substitution occurs,
MU of X will fall
and
MU of others will increase
until
equilibrium is restored
He focused on
substitution effect and income effect
( when consumer experienced gain in purchasing power)
Consumer Surplus
Therefore the price a person pays for a good never exceeds or / to what he/she willing to pay
Marshall is credited for using the concept
'consumer surplus'
and systematically exploring it.
TU of goods is the
sum of successive MU
of each added unit
Although there's problem, Marshall consumer surplus has proved to be valuable tool for
analyzing several economics phenomena-deadweight
or
efficiency losses from taxes,monopoly and tariff
In other words, the consumer surplus is therefore the
area below the demand curve and above the market price
NeoClassical
Elasticity of Demand
The
lower the price
, the
more consumer will buy
. So the demand curve slope downward to the right
Ed tells us whether the decrease of desire is slow or rapid as Q increase
Law of person desire for commodity-
other things being equal
, it diminishes with every
increase in his supply of commodity
In absolute term,
Ed > 1 demand is elastic
,
Ed < 1 demand is inelastic
,
Ed = 1 demand is unit elastic
Supply
Supply is governed by cost of production
divided into 3 periods
Intermediate present
Market price refer to present, no time allowed for adaptation of Quantity supplied to changes in demand
Market supply curve vertical straight line-perfectly inelastic. Bcs no matter how
high price, quantity supplied cannot be increased
Short run
To analyze the period he divided cost into 2 types:
supplementary cost
and
prime cost
SR is period where
variable inputs can be changed
, but
fixed cost cannot be changed
SR supply curve slope upward and to the right,the
higher the price
,the
larger Q supplied
Long run
All cost are
variable
and they
must be covered if firm wants to continue production
.
Equilibrium Price and Quantity
Marshall
Behind supply-financial and subjective cost
Behind
demand-utility and dmu
Both
demand and suppl
y
Using tables to
demand and supply
and
determination of equilibrium price and quantity
Distribution of Income
Business people constantly compare relative efficiency of every agent of production they employ
In competitive economy distribution of income is determine by pricing of factors of production
He based his analysis on the
diminishing returns
NeoClassical
Wages
It is correct to say wage measure are equal to MP with a given supply of labor
Not determine by Marginal Productivity of labor alone
Marshall is correct in
identifying demand for labor as a derived demand
and also discussed the determinants of wage elasticity of labor demand
4 laws
The greater the
price elasticity
of product demand,the greater the Ed for labor
The larger the
proportion of total production
cost accounted by labor,the greater the Ed for labor
The greater the
substitutability
of other factor for labor, the greater the Ed for labor
The greater the
elasticity of the supply
of other inputs, the greater the elasticity demand of labor
Interest
Rise in interest
diminishes the use of machinery
, bcs
businessman avoids use of all machin
e whose net annual surplus is less than rate of interest
Quantity of saving supplied
depends on rate of interest
, and
rate of interest depends on supply of savings
Lower interest rate
increase capital investment
Fall in interest rate will induce people to
consume more in present
Interest rate will move towards equilibrium
Profit,Rent, Quasi-Ren
t
Normal profits include
interest,earnings of management and supply price of business organizations
Remaining portion of
normal profits, supply price of business organizations
is reward to entrepreneurships
Earning of management are payment for specialized form of labor
Only
variable cost influence prices in short run
Price in turn determined the
earnings of fixed investment
.
Internal vs External Economies
Internal economies
Efficiencies or cost savings introduced by the
growth in size of individual firm
. As firm gets large they enjoy s
pecialization,mass production, using more and better machine
and thus
powering cost of production
External economies
Come from outside of the firm. They depend on the
general development of the industry that would affect the firm
Increasing and Decreasing Return to Scale
If we heavily depend on
agriculture
we would have
decreasing return to scale
Constant cost return
-an increased demand in product does not affect price in long run
Increasing return to scale-as labor and capital expand, organizatiion and efficiency improve. Increased demand will ultimately cause
price to fall
and more
be produced
Welfare, Taxes & Subsidies
A
tax
may add to
net consumer utility
in
increasing cost industry
A
subsidy
may add to
net consumer utility
in a
decreasing cost industry
Either
tax or subsidy
will
reduce net consumer utility
in a constant cost industry.