Module 1. Basic concepts of economics

Lesson 4

4.1 Introduction

This lesson describes few more important term used in economics.

4.2 Consumption

It is defined as satisfaction of human wants using goods and services. Whenever a person uses any good or avail any kind of service it is said to be consumed. e.g. In a training session, participants are consuming the infrastructure facilities as well as services of professional trainer. In consumption wealth of the person is utilized. Consumption causes destruction of utility along with satisfying human wants. e.g. when we are hungry, we eat the food. We pay for the food & satisfy our want. During the course of eating, utility of original food items get destroyed & converted into another form.

The consumption unction or inclination to consume refers to income consumption relationship.

It is a functional relationship between two aggregates i.e. total consumption and gross national income.

The relationship is represented as





F=Functional relationship between C & Y, where C is dependent and Y is independent variable

According to consumption function, consumption equals income over saving, thus

C=Y-S, where



S=Saving (S=I(investment))

4.3 Classification of Consumption

Consumption can be classified in to two broad categories as below

1. Direct Consumption: When the goods & services are consumed by the individuals in straight forward way to satisfy their wants, the process is called direct consumption e.g. eating food.

2. Indirect Consumption: The process of using the goods for manufacturing other goods which ultimately satisfy human want is called indirect consumption. e.g. using various capital equipments to manufacture various finished goods.

4.4 Significance of Consumption

Consumption is the base for all economic activities. Human beings consume goods & services to satisfy their diverse wants. This propels all the economic activities of production including distribution & marketing. The rate of consumption decides the pace of production which ultimately decides the economic growth of a country & standard of living of its citizen.

4.5 Demand and Supply

4.5.1 Demand

It is desire backed by purchasing power and willing to pay. Demand for a product is time place & price specific. Demand for any product is the quantity which a consumer decides to buy at a given price, at a given time.

4.5.2 Supply

It refers to the quantity of product bought for sale at a price during a particular period of time. Supply is dependent upon price of the product, price of other products, factor prices, and state of technology and objectives of the firm.

4.6 Consumer Supply

Consumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods.

Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (i.e. the market price for the product). The level of consumer surplus is shown by the area under the demand curve and above the ruling market price as illustrated in the Figure 4.1


Fig. 4.1 Consumer surplus

The concept of diminishing marginal utility state that the marginal utility of a commodity to a person tends to decrease as consumption is increased. Based upon this concept, a phenomenon of consumer surplus is derived. Due to the law of diminishing marginal utility a consumer is ready to pay more prices for initial units but fewer prices for subsequent units as its utility goes on decreasing. But consumer has to pay same price as all units of the item are same. By purchasing the commodity, consumer gets utility and price paid is viewed as sacrifice or disutility. A rational consumer will continue to purchase additional unit of a particular item, till a stage is reached when the utility of an additional piece is same as the disutility of the price paid to purchase it. Thus at this last unit buyer does not get any surplus, but as the consumer pays same money for all the units, they get additional utility in the form of consumer surplus. Consumer surplus is the excess what a consumer is willing to pay over which they actually pay. It is the difference between what consumers are prepared to pay and what they actually pay.

Consumer surplus = Total utility - total amount spent


For example a consumer intends to purchase ice cream for consuming. The price of ice cream per cup is Rs. 20. Marginal utility derived from consuming different ice cream cups and consumer surplus is given in following table.

Table 4.1 Consumer surplus


4.6.1 Utility of consumer surplus

The concept is useful for government to tax the commodities in which consumer are willing to pay more consumer surplus. It is helpful to business houses to set price. They can set higher price for those commodities for which consumers are willing to pay higher consumer surplus. It aids in international trade by importing some of the items at cheap rate for which consumer are paying more for local manufactured goods.

Last modified: Tuesday, 6 November 2012, 9:02 AM