Question

1. Explain the marginal utility and diminishing marginal utility. Provide an example of each concept.

2. Explain the income effect and the substitution effect

Answer 1

ANSWER-

1.) Marginal utility - Marginal utility means change in total satisfaction by consuming one more unit of a product. This concept is used to know that how much a consumer is willing to purchase. The marginal utility can be positive, zero or negative. It is positive when by consuming one more unit the total satisfaction (utility) increases. It is zero when consuming one more unit has no effect on total satisfaction. It is negative when by consuming one more unit the total satisfaction decreases. For example, by consuming coca cola the consumer will get some satisfaction and as it consumption increases there will be different satisfaction than the previous consumption. suppose by consuming the consumer gets total satisfaction of 10 and after conuming 2nd bottle he gets total satisfaction of 12 so marginal utility here is 2 (12-10).

Diminishing marginal utility - The law of diminishing marginal utility states that by consuming more andd more units of a product the satisfaction derived from each successive unit goes on decreasing. For example- As consumer goes on increasing consumption of a particualr product a point will come that consumer will get fully satisfied and it will not give any more satisfaction to the consumer.

2.) Income effect - Income effect is the change in quantity demanded by the consumer because of change is real income of the consumer. An increase in real income means the purchasing power of consumer will also increase and a decrease in real income means decrease in purchasing power and less quantity would be purchased by the consumer.

Substitution effect - Substitution effect show the change in demand for a good because of change in price of similar type of good. As with an increase in price of a particular good the consumer shifts it's demand to some other similar type of good. Suppose there are 2 similar types of goods X and Y now if price of X will rise the demand for Y will rise as it will seem relatively cheaper to consumer than X as both are similar types of goods. The substitution effect applies when there is no changein real income (purchasing power of the consumer).