E-LESSON-5 MICRO ECONOMICS-1 ENG

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B.A.English 2 All right are reserved with CU-IDOL Microeconomics-I Course Code: BAQ108 First Semester: 5 e-Lesson: 5 SLM Unit: www.cuidol.in Unit-5(BAQ108)

MICRO ECONOMICS 33 OBJECTIVES INTRODUCTION In this unit we are going to learn Students will be able to develop about the concept OF Consumer understanding about the economic Surplus. concept of consumer’s surplus. Students will be able to measure the Under this you will be able to consumer’s surplus. describe how to derive consumer surplus. Students will be able to Explain the practical use of the concept of consumer’s surplus. www.cuidol.in Unit-5(BAQ108) INSTITUTE OF DISTANACEll ArNigDhtOaNrLeINreEsLeErAvRedNIwNiGth CU-IDOL

TOPICS TO BE COVERED 4  Consumer Surplus. Measurement of Consumer Surplus Importance and Criticism of Consumer Surplus. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Consumer surplus-Definition 5 Definition: Consumer surplus (CS) is the difference between the total amount of money the consumer would have been willing to pay for a quantity of a commodity and the amount he actually had to pay for it. The concept of consumer’s surplus is based on the law of diminishing marginal utility. Prof. Marshall used the phrase “consumer’s surplus” for the difference between the sum which measures total utility and that which measures total exchange value (i.e., the price paid). www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

CONSUMER SURPLUS 6  Consumers buy goods because it makes them better off (or provide utility). Consumer Surplus measures how much better off they are.  Consumer Surplus from each unit: The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Measurement of Consumer’s 7 Surplus Consumer’s Surplus = Total Utility – (Price × Quantity) In symbolic terms: Consumer’s Surplus (CS) = TU – (P × Q) Where, TU = total utility Q = quantity of the commodity P = price www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Diagrammatic Representation 8 of Consumer Surplus: In this diagram AB is a demand curve of a consumer OR is the market price. The price line is parallel to X axis because of perfect competition. At point P the marginal curve AB intersect the market price curve OR. Thus for OQ quantity the consumer derives utility as AOQP where as he pays ROQP. Thus, triangular shaded area ARP is Consumer’s Surplus . Consumer’s Surplus = Total Utility-(Marginal Utility) x (Multiply x No. of Units purchased) www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Assumptions of the Marshallian 9 Approach 1. Cardinal measurement of utility: The benefits gained by the consumer from his purchase of a commodity is quantified by Marshall on the assumption of cardinal or numerical measurement of utility. 2. Diminishing marginal utility: The concept of consumer’s surplus also incorporates the law of diminishing marginal utility. Thus, excess of utility tends to decline when the consumer buys more of a commodity, the price remaining the same. Thus, the last unit purchased by the consumer of equilibrium point has zero consumer’s surplus, since he stops buying at the point when MU = price, so there is no extra gain of utility. The concept of CS thus involves ceteris paribus assumptions underlying the law of DMU. 3. Constant marginal utility of money: It is assumed that marginal utility of money remains constant throughout the process of exchange. This assumed to eliminate the influence of income effect in the measurement of CS. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Assumptions of the Marshallian 10 Approach 4. Existence of no substitutes: Marshall assumed that the commodity in question has no substitutes. In his view, for the measurement of CS, each commodity is to be treated as an absolutely independent one. On practical considerations, he suggested that in cases where substitutes are found, they should be grouped together to form a single commodity 5. Specificity of utility: Marshall assumed that utility of a commodity depends specifically on the quantity of that commodity alone. Therefore, each commodity should be regarded as an independent commodity. This calls for the assumption of no substitutes, as mentioned above. The validity of Marshallian concept of consumer’s surplus obviously depends on the fulfilment of these assumptions. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Criticisms 11 1. Unrealistic assumptions: Marshall’s doctrine of consumer’s surplus is based on unrealistic assumption, for: (a) Utility cannot be measured cardinally; therefore, consumer’s surplus cannot be measured and expressed numerically. (b) Marginal utility of money does not remain constant. (c) If commodities have substitutes, with a rise in prices, he will purchase other goods rather than pay a higher price for the same. The concept has no theoretical validity, as no commodity can be treated as absolutely independent. 2. Measurement impossible: Marshall tries to express the gain of consumer’s benefit from a commodity in terms of money through the measurement of difference between what he would be willing to pay and what he actually paid. And, again, he assumed marginal utility of money to remain unchanged throughout the demand curve. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Criticisms 12 3. Meaninglessness of the concept in certain cases: It is meaningless to apply the doctrine of CS to necessaries. Because, in the case of necessaries like water, consumer derives infinite utility and would be willing to pay anything he can rather than go without it. Thus, in the case of necessaries like water, CS may be infinite. It is, however, absurd or meaningless to say that every time a consumer drinks a glass of water, he enjoys immense consumer’s surplus. 4. It is a hypothetical and illusory concept: To some, the concept of CS is imaginary and illusory. It does not exist in reality. We create a CS is our imagination. There is no factual .realisation of CS, by an ordinary consumer 5. No empirical test: Marshall did not provide any data or empirical evidence in support of this concept. It is a purely subjective phenomenon, not capable of empirical testing, either. 6. Impractical concept: Critics like Little Feel that the concept of CS has no practical utility. “The doctrine of consumer’s surplus is a useless theoretical toy, having no practical significance,” says Prof. M.I.D. Little. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Importance of the Concept of 13 Consumer Surplus 1. It clarifies the paradox of value: The concept of consumer’s surplus is useful in clarifying the paradox of value by showing the distinction between value-in-use and value-in-exchange. Paradox of value may be seen in the market value of some commodities like diamond and water. Water has immense value- in-use but little price or value-in-exchange, while diamond has high value-in-exchange despite its low usefulness. Consumer’s surplus depends on the difference between total utility and price and price depends on marginal utility. A high consumer’s surplus thus implies high value-in-use, compared to the value-in-exchange of a commodity 2. Conjuncture advantage: The concept of consumer’s surplus does emphasise the amenities that we enjoy in a modern economic society. Much of the consumer’s surplus we enjoy, depends on our surroundings and opportunities of consumption available to us.The larger the consumer’s surplus, better off is the people. The concept, thus, serves as an index of economic betterment. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Importance of the Concept of 14 Consumer Surplus 3. Importance to the monopolist: It is useful in determining the policy of a monopoly firm. The monopolist can put a higher price on goods if the consumer’s surplus is high, without causing any reduction in so. 4. Importance in taxation policy: It is of great significance to exchequer in determining indirect taxation. The finance minister can levy more taxes where consumer’s surplus is high. 5. Importance in welfare economics: By estimating the difference in consumer’s surplus resulting from a change in price, we can now compare the effects of a given change in the price of any commodity on the different classes of people, it is, therefore, widely adopted in welfare economics. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Multiple Choice Questions Q.1. The concept of consumer surplus indicates__________from goods he purchases in a 15 market economy. (b) Consumer’s gain (a) consumer’s satisfaction (d) All the above (c) Consumer’s need Q2. Measurement of consumer surplus equation is (a) CS =TU- (P X Q) (b) CS = TU + (P X Q ) (c) CS = (P X Q) (d) All the above Q3. Marginal utility of money does not remain constant. (a) both (b) No (c) Yes (d) None. Q4. The finance minister can levy more taxes where consumer’s surplus is__________ (a) Low (b) Medium (c) Constant (d) High Answers: 1. (b) 2. (a) 3.( c) 4.(d) www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Summary 16  Consumer surplus refers to the extra satisfaction derived from the purchase of goods.  Consumer Surplus (CS) =(Total utility) - (P × Q)  CS based om diminishing managerial utility.  CS is on illusory concept.  Marshall did not provide any empirical evidence in stating CS.  CS concept clarifies paradox of value  It is useful to monopolist in pricing policy.  CS concept is useful to govern is determination of commodity taxation  Imposition of high taxes on goods having large CS. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

Frequently Asked Questions 17 Q1.Define Consumer Surplus? Answer: Consumer surplus (CS) is the difference between the total amount of money the consumer would have been willing to pay for a quantity of a commodity and the amount he actually had to pay for it. Q2. What are the assumptions of Consumer Surplus? Answer: Marginal Utility of Money is Constant, No Close Substitutes Available, Utility can be Measured,Tastes and Incomes are Same. (Explain each in details) Q3. Explain the importance of Consumer Surplus? Answer: Consumer's Surplus is useful to the Finance Minister in formulating taxation policies. It is also helpful in fixing a higher price by a monopolist in the market, based on the extent of consumer's surplus enjoyed by consumers. Consumer's Surplus enables comparison of the standard of living of people of different regions or countries. This comparison helps to distinguish consumption levels between the people, who are living in rich countries and poor countries www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

REFERENCES 18 1. Ahuja, H.L.(1999). Advanced Economic Theory. New Delhi: S.Chand&Co. 2. Chopra,P.N.(1998). Micro Economic Theory and Welfare Economics. New Delhi: Kalyani Publishers. 3. Chopra,P.N.(2006). Advanced Economic Theory. New Delhi: Kalyani Publishers. 4. Lekhi, R.K., Walia, H.S. & Talwar,S.J.(2003).Micro Economics. New Delhi: Kalyani Publishers. 5. Lipsey,R.G. & Chrystal, K.A.(2004). Economics. New Delhi: Oxford University Press. 6. Mandal,R.K.(2007). Micro Economics Theory. New Delhi: Atlantic Publishers. 7. Ray, N.C.(1980). An introduction to Micro Economics. New Delhi: The Macmillan Company of India. 8. Salvatore,D. (2003). Micro Economics: Theory & Applications. New York: Oxford University Press. 9. Singh,M. (1971). MangSidhant Ate Mishrat Arth-VivsthaVich Arthik Ganana. Patiala: Punjabi University. 10. Vohra, P.& Mehta,R. (2007). Micro Economics. New Delhi: Commonwealth Publishers. www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL

19 THANK YOU For queries Email: [email protected] www.cuidol.in Unit-5(BAQ108) All right are reserved with CU-IDOL