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Home Theory of Consumer Behavior Derivation of the Demand Curve in Terms of Utility Analysis

Derivation of the Demand Curve in Terms of Utility Analysis:

 

Dr. Alfred Marshal was of the view that the law of demand and so the demand curve can be derived with the help of utility analysis.

 

He explained the derivation of law of demand:

 

(i) In the case of a single commodity and (ii) in the case of two or more than two commodities. In the utility analysis of demand, the following assumptions are made:

 

Assumptions:

 

(i) Utility is cardinally measurable.

 

(ii) Utilities of different commodities are independent.

 

(iii) The marginal utility of money to the consumer remains constant.

 

(Iv) Utility gained from the successive units of a commodity diminishes.

 

(1) Derivation of Demand Curve in the Case of a Single Commodity (Law of Diminishing Marginal Utility):

 

Dr. Alfred Marshall derived the demand curve with the aid of law of diminishing marginal utility. The law of diminishing marginal utility states that as the consumer purchases more and more units of a commodity, he gets less and less utility from the successive units of the expenditure. At the same time, as the consumer purchases more and more units of one commodity, then lesser and lesser amount of money is left with him to buy other goods and services.

 

A rational consumer, before, while purchasing a commodity compares the price of the commodity which he has to pay with the utility of a commodity he receives from it. So long as the marginal utility of a commodity is higher than its price (MUx > Px), the consumer would demand more and more units of it till its marginal utility is equal to its price MUx = Px or the equilibrium condition is established.

 

To put it differently, as the consumer consumes more and more units of a commodity, its marginal utility goes on diminishing. So it is only at a diminishing price at which the consumer would like to demand more and more units of a commodity.

 

Diagram/Curve:

 

 

In fig. 2.4 (a) the MUx is negatively slopped. It shows that as the consumer acquires larger quantities of good x, its marginal utility diminishes. Consequently at diminishing price, the quantity demanded of the good x increases as is shown in fig. 2.4 (b).

 

At X1, quantity the marginal utility of a good is MU1. This is equal to P1 by definition. The consumer here demands OX1 quantity of the commodity at P1 price. In the same way X2 quantity of the good is equal to P2. Here at P2 price, the consumer will buy OX2 quantity of commodity. At X3 quantity the marginal utility is MU3, which is equal to P3. At P3, the consumer will buy OX3 quantity and so on.

 

We conclude from above, that as the purchase of the units of commodity X are increased, its marginal utility diminishes. So at diminishing price, the quantity demanded of good X increases as is evident from fig. 2.4 (b). The rational supports the notion of down slopping demand curve that when price falls, other things remaining the same, the quantity demanded of a good increases and vice verse. (The negative section of the MU curve does not form part of the demand curve, since negative quantities do not make sense in economics).

 

(2) Derivation of the Demand Curve in the Case of Two or More than Two Commodities (Law of Equi-Marginal Utility):

 

The law of diminishing marginal utility can also be applied in case of two or more than two goods. When a consumer has to spend a certain given income on a number of goods, he attains maximum satisfaction when the marginal utilities of the goods are proportional to their prices as stated below.

 

MUx / Px = MUy / Py = .. MUn / Pn

 

Derivation of Demand Curve:

 

In the fig. 2.5 (a), (b) and (c) given the money income, the price of X commodity (Px) and the price of Y commodity (Py) and constant marginal utility of money (MUm), the demand curve derived is illustrated. The consumer allocates his money income between X and Y commodities to get OQ1 units of good X and OY unit of good Y commodities because the combination correspondence to:

 

MUx / Px = MUy / Py = MUm

 

At the OM level (constant).

 

Diagram/Curve:

 

 

 

 

Let us assume that money income and price of Y commodity remain constant but the price of X commodity decreases. As a result of this money expenditure on commodity X rises resulting MUx / Px curve to shift towards right. The consumer now allocates his income to OQ2 quantity of X commodity and Oy quantity of Y commodity because the combinations correspondence to

 

     MUx / Px = MUy / Py = MUm

 

(constant) at OM level.

 

Thus in response to decrease in the price from Px to Px1, the quantity demanded of a good X increases from OQ1 to OQ2. The DD is a negatively sloped demand curve.

Relevant Articles:

Cardinal Utility Analysis
Total Utility and Marginal Utility
Law of Diminishing Marginal Utility
Law of Equi Marginal Utility
Derivation of the Demand Curve in Terms of Utility Analysis
 

 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
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Rent
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Principles and Theories of Macro Economics
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Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
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Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
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Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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