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"Indifference curve analysis provides a superior explanation of the shape of the demand curve, however, the concept of diminishing marginal utility provides a better framework for understanding the nature of demand" Discuss.

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Introduction

"Indifference curve analysis provides a superior explanation of the shape of the demand curve, however, the concept of diminishing marginal utility provides a better framework for understanding the nature of demand" With reference to the fore mentioned theory, critically evaluate this statement. Demand is usually seen as what someone would like to have. But in an economic sense it is what someone would like to have, plus the fact that they have the ability to purchase it is as well. Only when the willingness to purchase it is backed up by the purchasing power to buy it is it called Effective Demand. Utility is derived from a product when it provides satisfaction. The amount of utility taken by someone from a product is different for each product and each individual person. There is no such thing as a unit of satisfaction. Yet the concept must still exist in order for the product to have utility and in turn be demanded. It is assumed that when choosing something to purchase, consumers will act rationally; this is called Rational Economic Man. ...read more.

Middle

From this, it is straightforward to presume that a cut in price will boost the amount demanded. Demand Curves illustrate the relationship between the price of a product and the quantity of it demanded over a certain period of time. An example that could be used involves beer consumed by a man. Price of Pint Pints demanded each week �3.50 2 �3.00 3 �2.50 4 �2.00 5 �1.50 6 As I have shown in the table, the amount consumed will go up when the price falls. I have drawn a demand curve of this relationship, as shown on the back page. The line connecting the 5 observations is called the demand curve. In general these demand curves show the nature of the demand over a certain period of time. Indifference curves Many of the models used to understand and describe individual human behaviour are based on the concept of utility maximization. These models are written as: Max U = f (X, Y) ...read more.

Conclusion

We summarize this assumption by saying that preferences are complete. The second assumption states that if 'b' is preferred to 'a' and 'a' is preferred to 'c' then it must be true that 'b' is preferred to 'c'. This is known as the transitivity condition. The third assumption is straightforward in that greater quantities provide greater levels of satisfaction to the individual. This is known as non-satiation. Indifference curves can't intersect, and they must slope left to right. An example of an indifference curve is shown on the back page. If two goods: books and films are considered: A given consumer desires both goods Points a, b, c, d, e each represents different combinations of these two goods. From assumptions 1 and 2 the consumer will decide on one of the following: * c > b, a preference for the bundle with more films * b > c, a preference for the bundle with more books * c ~ b, indifference between a bundle that contains more films and fewer books and the bundle with more books and fewer films (due to the fact they are on the same curve. ...read more.

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