Business Economics

December 2021 Examination

Q1. What is Indifference Curve, explain with the help of diagram and also
explain its properties. (10 Marks)

Answer 1.

Introduction
Indifference curve:
The indifference curve illustrates how consumers behave based on their
indifference towards certain groups of goods and services. The consumer is
equally satisfied by all combinations in an indifference curve. Normally, an
indifference curve is designed to be convex to the origin. Assuming that
marginal utility/marginal satisfaction diminishes, this statement is correct. The
extra utility we gain from consuming extra unit’s decreases as the total utility
increases at a diminishing rate.
We assume that the combined utility of products further from the origin will be
greater. Analysing difference curves typically relies on a simple two-
dimensional graph. The axes represent different types of economic goods. Any
combination of goods on an indifference curve offers the same level of utility to
the consumer, so the consumer is indifferent between any combinations of
goods on the curve. Studying the indifference curve requires one to assume the
curve's ordinal theory.
A rational customer shops for goods. It is possible to have ordinal utility, non-
satiety, and transitivity. There are only commodities that a consumer is inclined
to purchase, and marginal rates of substitution diminish as time passes. A
complementary good isn't an ideal substitute for an appropriate substitute. The
substitution may be partial. In spite of this, there is no perfect substitution
between the two commodities purchased by the consumer and displayed in the
graph.
Concept and application
The Diminishing Marginal price of Substitution is the charge at which a
consumer sacrifices a few proportions of a commodity to grow the amount of
another thing. In order to ensure that the graph derived from the combination of
these commodities remains constant, the purchaser does so in order to keep it
from changing.
As a result, the slope of an indifference curve relies upon a purchaser's
willingness to allow go of one item for increasing the amount of every other
thing.
Let's look at an example to gain a better understanding of the concept of the
difference curve. Assume that a purchaser intended to purchase food and
grocery from the aggregate of these categories. There are four plausible
mixtures for him to choose from according to the stage of utility he would like
as well as the constant income.
In this section, you will find a graphic representation of the difference curve
using the four mixtures we examined earlier.

Indifference
14

12

10

8 Indifference

0
0.5 1 1.5 2 2.5 3 3.5 4 4.5

The indifference curve shows that when the purchaser is shopping 1 unit of
food, he prefers 12 units of grocery. The pleasure level at the first combination
is identical to the pleasure degree when the consumer buys two units of meals
and six units of grocery. Similarly, the pleasure level will stay consistent at all
four combinations. Besides those four mixtures, another opportunity of the two
commodities that lies in this indifference curve will offer the same level of
pleasure to the consumer.
With this, we will be able to easily distinguish between the different
characteristics of an indifference curve. In order of significance, the following
are the five characteristics:

1. It is always convex to the origin when an indifference curve is

considered. As seen in the instance, the consumer substitutes or
sacrifices grocery units for more excellent food units. It's far known as
the Diminishing Marginal Rate of Substitution. This charge is the purpose
behind the convex shape of the indifference curve. But if commodities
bought by way of the consumer are the best substitutes, then the
indifference curve might be a direct line with constant MRS.
Additionally, if the two commodities are perfectly complementary, the
indifference curve can be convex to the origin and in L shape.

2. The indifference curves of two equal distributions never intersect

with one another. To a consumer, each indifference curve provides a
different level of enjoyment or dissatisfaction. Hence, two indifference
curves can never meet or intersect every differently. The two indifference
curves can by no means provide the equal application or delight stage to
the customer. Think the two indifference curves intersect each other. In
that case, and it will suggest that one or more mixtures within the two
curves offer an equal degree of satisfaction. That's not possible.

3. Asymptotically to the axes: In the indifference curve, we count on the

consumer shopping the commodities spending cash on each merchandise
from among the possible combinations supplying the equal satisfaction
level. It way that no entity could have zero units of quantity; and hence,
an indifference curve can in no way contact the x-axis and y-axis.

4. An indifference curve has an at once proportional degree of pride. If

an indifference curve is higher, then the pleasure degree from those
combinations may be extra. It's miles because an excessive indifference
curve depicts greater or massive quantities of two goods.
 5. The slope of an indifference curve is lousy. The entire utility stage
derived from distinctive combinations of two items is equal, resulting in a
downward indifference curve slope. Because the increase in intake of 1
commodity will increase the satisfaction level, the discount in the
quantity of the second commodity reduces the satisfaction stage. This
reduction and increment inside the pleasure degree balance the total pride
stage of a mixture.

Conclusion

1. Subsequently is based on the application level. , we can conclude that an

indifference curve is a graph which states that after there's a growth in a
single item , decreases the other commodity's graph stage respectively,
the overall application from both entities remains equal at each aggregate
or possibility of two goods. Additionally, the indifference curve is an
alternative to the marginal utility analysis of a commodity's demand.
 2. Consider the demand for a good. At price Rs 4, the demand for the
good is 25 units. Suppose price of the good increases to Rs 5, and as a
result, the demand for the good falls to 20 units. Calculate the price
elasticity? (10 Marks)

Answer 2.
Introduction

The elasticity of demand: In contrast, the elasticity of demand measures the

impact of a change in an economic variable on the quantity demanded in a
market. Demand for a product is influenced by a variety of factors, such as
income levels within a segment, price of the product, and the price of other
products in that segment. This measure assesses how much change is
observed in demand in response to changes in any of the variables in the
market, like price, income, etc. Demand changes when other factors in the
economy change. The elasticity of demand is defined as the difference
between the number of items demanded and another economic variable
divided by the number of items demanded. In other phrases, the elasticity of
demand for a thing is the sensitivity at which the direction of a commodity
alternate with the change in specific monetary elements affecting the market.
A commodity or carrier may have five varieties of elasticity of demand. These
are flawlessly elastic, elastic, unitary, inelastic, and flawlessly inelastic.
Primarily based on the pliancy of the market, the products can be labelled, as
usual, inferior, luxurious, necessity, replacement, or complementary items. As
demand regulation states an inverse relationship between the demand and
price of a commodity, the elasticity of demand for a thing may be acceptable
or terrible. In contrast, the issue affecting the market is price.

Concept and application:

Price elasticity of demand: An individual's demand changes in response to a

change in the price of a product. This is known as price elasticity of demand. In
different words, rate elasticity of demand is the percentage alternate in demand
of a commodity because of the proportion change in its price. The price
elasticity of demand for particular items is exclusively based totally on the
factor affecting the charge of the goods. Various factors that affect the rate
elasticity of demand are the provision of the close substitutes of the best (a good
with more substitutes have extra elasticity than a good with no close
substitutes), the nature of the commodity whose elasticity of demand is being
decided (a good may be a need, luxurious, regular, inferior, or comfort right),
the share of profits spent through the consumer at the commodity(if the
consumer spends extra money on accurate then the elasticity could be more),
the price level of the item inside the market (usually the elasticity of a
commodity with high price is extra), taste, preference, and habits of the
purchaser, and earnings stage of the consumer.
The given question states that the price of a very good has modified from Rs. 4
to Rs. 5, which has dropped the demand for the good from 25 units to 20 units.
We are supposed to calculate the charge elasticity of demand for the good. For
this, the system that we can use is,

Price elasticity of demand =

Percentage change ∈quantity demanded

Percentage change∈the price of the product

Percentage change in quantity demanded =

Q1−Q
x 100
Q

Percentage change in price =

P 1−P
X 100
P

Q is the original quantity demanded by the customer for a good or service,

𝑄1 does the customer demand the new quantity,
P is the original price of the commodity,
And 𝑃1 is the new price of the commodity.
As per the given question, Q = 25 units, Q1 = 20 units, P = Rs 4, and P1= Rs 5

Percentage change in quantity demanded =

 Q1−Q
x 100
Q

20−25
= 25
X 100

−5
= 25 X 100

= -20%

Percentage change in price =

P 1−P
X 100
P

5−4
= 4
X 100

1
= 4 X 100

= 25%

Now we can calculate the rate elasticity of demand for the best with the help
of computed values of percentage exchange in the amount demanded and
percent exchange in the fee of the stated items.
Price elasticity of demand =

Percentage change ∈quantity demanded

Percentage change∈the price of the product
−20 %
= 25 %

= -0.8%
The price elasticity of demand for the good is – 0.8 or 0.8. The price elasticity
of demand is less than one, which states that the best bought by using the
consumer has inelastic demand. Even as determining the elasticity of a
commodity, an individual ought to preserve one element in thoughts: the wrong
sign of the price of rate elasticity of demand is neglected because it depicts the
inverse dating between the charge and direction of a commodity. For this
reason, we've taken into consideration the value of price elasticity of demand as
0.8. Also, a relatively inelastic demand means that the price of the commodity
adjustments at a better price than the price at which quantity demanded the
commodity adjustments. It can be because of the lack of substitutes, infrequent
buyers, purchaser necessities, geographical regions, or other seasonal elements.
Conclusion
After the above explanation of how to estimate the price elasticity of demand
for an amazing product, and the calculation of the price elasticity of demand
specifically stated, we will conclude that six different aspects of human
behaviour might affect the price elasticity. Also, the price elasticity of demand
may differ for distinct commodities based on the factors affecting their market
inside the consumer. We have also learned that the rate elasticity of demand for
an entity may be equal to zero, infinite, equivalent to one, less than one, or more
than one. It categorizes the elasticity of demand as unit elastic, perfectly elastic,
flawlessly inelastic, elastic, or inelastic demand.

3.a. Two goods have a cross-price elasticity of demand of +1.2 (a) would
you describe the goods as substitutes or complements? (b) If the price of
one of the goods rises by 5 per cent, what will happen to the demand for the
other good, holding other factors constant? (5 Marks)

Answer 3a.

Introduction
The elasticity of demand: A commodity's demand elasticity refers to how it
responds to alterations in elements affecting the direction of its demand based
on adjustments in elements affecting its direction. A number of factors influence
consumer choice and taste, consumer earnings, the price of other products, the
price of the products, etc.

Concept and application

Cross elasticity of demand: The cross elasticity of demand is used to illustrate

the sensitivity of a commodity's demand when there is a shift in the price of the
corresponding product. In other words, the go elasticity of demand is the
proportion exchange in the direction of a commodity because of the proportion
exchange in the price of other alternative or complementary goods.
Replacement items can be replaced if one offers a better graph level than the
alternative, such as tea, coffee, etc. The rise in the price of one accurate will
grow the demand for its substitute precise and vice-versa.
Complementary items are goods that can't be replaced with every other. Instead,
those goods are typically used together—for instance, bread and butter and
many others. The rise in the price of one goodwill decreases the demand for the
complementary product.
a) The go elasticity of demand for the given goods is positive 1.2. Because of
this, the goods are replacement items. The excellent value depicts that an
upward push inside the price of one goodwill grows the amount demanded of
the other related accurately.
b) Now, it is given that there may be a 5% rise in the price of 1 commodity with
1.2 cross elasticity of demand, and we should calculate the change in the
amount demanded of some other commodity while retaining other factors
constant. For this cause, we can use the following formula,

Cross Elasticity of Demand =

 Percentage change∈quantity demanded ( X )
Percentage change∈the price of other goods (Y )

Percentage change in quantity demanded =

∆ Qx
x 100
Qx

Percentage change in price =

∆ Py
X 100
Py

Where,
ΔQ𝑋 is the change in quantity demanded of commodity X
Q𝑋 is the quantity demanded of commodity X
Δ𝑃𝑋 is the change in the price of commodity Y
𝑃𝑋 is the price of commodity Y

Percentage change ∈quantity demanded(X )

1.2=
5%

Percentage change in quantity demanded = 6%

Conclusion
By comparing the percentage change in quantity demanded to the percentage
change in quantity supplied, we can confirm that the goods remain substitute
items. Those goods may be either close substitutes or susceptible substitutes.
The associated products will have either positive or negative move elasticity of
call for. Then again, the move elasticity of demand for unrelated products will
be zero.

3.b. Calculate Marginal Utility and Average Utility from the information
given in the below table: (5 Marks)
 Quantity Consumed Total Utility
1 20
2 35
3 47
4 55
5 60

Answer 3b.

Introduction

Utility: A good or service's utility is the level of total satisfaction it gives when
consumed. According to economic theories based on rational choice, consumers
strive to maximize utility. Economic utility is crucial for understanding because
it directly affects demand and therefore price. The utility of a consumer cannot
be measured or quantified. Yet some economists believe they can indirectly
estimate a product's utility by applying various models.

Concept and application

Marginal utility: The additional satisfaction level a consumer gains from

consuming an extra unit of the commodity. And because of diminishing
marginal utility, as the consumer increases the consumption of goods or
services, the marginal utility declines. The formula for calculating marginal
utility is,

Change∈total utility
Marginal Utility=
Change∈quantity consumed

Average utility: It is the satisfaction level of a consumer by consuming one

unit of a commodity. It can be derived by dividing the total utility by the
quantity consumed by the consumer. The formula for calculating average utility
is,
Total Utility
Average Utility
Quantity Consumed

In the given question, we have the details about a good's total utility and the
number of units consumed by the consumer. Let us determine the marginal
utility and average utility for the five consumption levels with the help of the
formula mentioned above.
For 1 unit,
Average Utility = 20/1 = 20
Marginal Utility = (20-0)/(1-0) = 20

For 2 units,
Average Utility = 35/2 = 17.5
Marginal Utility = (35-20)/(2-1) = 15

For 3 unit,
Average Utility = 47/3 = 15.67
Marginal Utility = (47-35)/(3-2) = 12
In the same way, we can calculate the marginal utility and average utility for the
following two consumption levels of the consumer.
Quantity Total Utility Average Utility Marginal Utility
Consumed
1 20 20 20
2 35 17.5 15
3 47 15.67 12
4 55 13.75 8
5 60 12 5

With the help of the table, we can see that the marginal utility of the consumer
declines with the increase in the number of units consumed but remains
optimistic. It means that one extra team of the commodity provides more
satisfaction to the consumer. The average utility also decreases with the increase
in the number of units consumed and the consumer's total utility.

Conclusion
From the above discussion, we can conclude that utility is the satisfaction power
of a commodity. Having said that, different consumers are different, and it is not
true that an addict will ever enjoy himself to the fullest, regardless of the
amount of cocaine he may consume. Non-addicts, by contrast, will obtain some
level of satisfaction within quite a short period of time. Also, the satisfying
power of a commodity does not prove its usefulness. To conclude, we can say
that utility is psychological in nature and cannot be measured objectively.