BUSINESS ECONOMICS

1.
INTRODUCTION:

Indifference curve is the locus of points representing different combinations of

two substitutes, which yields the same level of utility or satisfaction to a consumer. As
an individual consume variety of goods over the time and realize that one good can be
substituted with another and he/she can make a choice between the two goods without
compromising with his/her satisfaction level. For example: if a person likes coffee
and soft beverages both and the prices of soft beverages rises, he can easily substitute
soft beverages with coffee without compromising on his satisfaction level.
When consumption of soft beverages rises, consumption of coffee will
decrease. When these combinations are plotted on the graph, the resulting curve is
called Indifference curve. This curve is also called Iso-utility curve or equal utility
curve. For example, let us assume that a consumer consumes two foods i.e. burger and
pizza and make combination for the two foods as shown below:

As shown in the table, the 5 combination depicts that the consumer when
decrease the consumption of one commodity, simultaneously increased consumption
of the other. The above mentioned combinations when plotted on graph will give a
curve as shown in the below graph. The X-axis indicates consumption of units of
Pizza and the Y-axis indicates consumption of units of Burger by the consumer. Each
point on the indifference curve is indicating that the consumer is indifferent between
the two and all points give him the same utility and equal level of satisfaction.

CONCEPT :
Properties of Indifference Curve (IC):

(1) Indifference curve is negatively sloped and convex to the origin : The curve is
always sloped downward to the right because when the consumer increases the
consumption of the commodity X, he is sacrificing some units of commodity Y, so as
to maintain the level of satisfaction and utility. This curve is sloping inward making a
convex to the origin for the reason that the consumer is continuing to substitute
commodity X for commodity Y, which results in diminishing of Y along the
indifference curve.
(2) Higher IC represents higher level of satisfaction : The higher indifference curve
will always represents higher level of satisfaction than the lower indifference curve.
In other words, the combination on the higher indifference curve will give the
consumer more satisfaction than the combination on the lower indifference curve
because the combinations have more goods of X and Y than the other combination.
The consumer will always prefer the combinations such as AB to any combination on
IC1. Therefore, it is concluded that the higher IC represents higher level of
satisfaction and combinations on it will be preferred to the combinations on the lower
IC.

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2.
INTRODUCTION :
The quantity demanded of a product changes greatly in response to changes in
in its price, it is termed as ‘Elastic’, i.e the demand point for the product is stretched
far from its prior point. If the quantity purchased shows a small change after change in
its price, it is called as ‘Inelastic’.
Price elasticity of demand is a measure of a change in the quantity demanded
of a product due to change in the price of the product in the market. In other words,
Price elasticity is a measurement of the change in consumption of a product in relation
to a change in its price.
 Price elasticity is used to understand how supply and demand for a product
changes when its price changes. Economists have found that prices of some goods are
very inelastic, which means, a reduction in price does not increase demand much and
an increase in price does not hurt demand either. For example; petrol has price
elasticity of demand. Drivers will continue to consume as per their requirement, as
will airlines, trucking industry and nearly every other buyer. So price hike would not
have as much effect on gasoline as before. Other goods are more elastic as price
changes for these goods would cause substantial changes in their demand or their
supply.
It can be mathematically expressed as:

Price elasticity of demand = Percentage change in quantity demanded

Percentage change in price

Thus, the formula for calculating the price elasticity of demand is as follows:
�� = Q × P
P Q
Where,
Ep = Price elasticity of demand
P = Initial price
P = change in price
Q = Initial quantity demanded
Q = Change in quantity demanded

There are 5 types of price elasticity:˃

(i) Perfectly Elastic Demand: When a small change (rise or fall) in the price results
in a large change (fall or rise) in the quantity demand, it is known as Perfectly elastic
demand. In this case elasticity of demand is (infinity).

(ii) Perfectly Inelastic Demand : When a change (rise or fall) in the price of a
product does not bring any change (fall or rise) in the quantity demanded, the demand
is called perfectly inelastic demand. The elasticity of demand, in this case, is Zero.

(iii) Relatively Inelastic Demand : When a proportionate or percentage change (fall

or rise) in price results in greater than the proportionate or percentage change (rise or
fall) in quantity demanded, the demand is called relatively inelastic demand. In this
case elasticity of demand ˃1.

(iv) Unitary Elastic Demand : When a percentage or proportionate change (fall or

rise) in price results in less than the percentage or proportionate change (rise or fall) in
demand, it is called unitary elastic demand. In this case, elasticity of demand <1.
Therefore, solution of the given question according to the formula is as under:
�� = Q × P
P Q
=5 ×4
1 25
= 0.8
Price elasticity of demand = 0.8

3.
(3A)
Cross elasticity of demand is defined as a measure of a proportionate change in the
demand for goods as a result of change in the price of related goods. According to
Ferguson, “The cross elasticity of demand is the proportional change in the quantity
demanded of good X divided by the proportional change in the price of the related
good Y”. The cross elasticity of demand can be measured as:

Ec = Percentage change in quantity demanded of X

Percentage change in price of Y

Cross elasticity of demand is categorised into 3 types:

(i) Positive cross elasticity of demand : When there is an increase in the price of a
related product results in an increase in the demand for the main product and vice
versa, the cross elasticity of demand is said to be positive. It is positive in case of
substitute goods.

(ii) Negative cross elasticity of demand : When increase in the price of a related
product results in the decrease of the demand of the main product and vice versa, the
elasticity of demand is said to be negative. It is negative in case of complementary
goods.

(iii) Zero cross elasticity of demand : When a proportionate change in the price of
related product does not bring any change in the demand for the main product, the
negative elasticity of demand is said to be zero. It is zero in case of independent goods.

(a) The goods are substitute goods because the cross elasticity of demand is +1.2
which is greater than 1 and it falls under Positive cross elasticity of demand.

(b) Holding all other factors constant, if the price of one of the goods rises by 5%,
then there would be no change in the demand for the other goods. It would fall
under independent goods. In simple words, cross elasticity is zero.

(3B)
Utility is defined as a measure of satisfaction received by a consumer on the
consumption of a good or service. The concept of utility can be seen from 2
perspective: from the product perspective and from the consumer perspective. From
the product perspective, utility is the ability of a product to satisfy want. On the other
hand, from the consumer perspective, utility is the psychological feeling of
satisfaction, happiness, etc. That a consumer gain from the consumption of a good.

(i) Total Utility : It is defined as the sum of the utility derived by a consumer from
the different units of a commodity or service consumed at a given period of time. It is
measured as follows;
Total Utility = U1+U2+U3+U4

(ii) Marginal Utility : It is defined as the utility derived from the marginal or
additional unit of a commodity consumed by an individual. In simple words, it is
defined as the addition to the total utility of a commodity resulting from the
consumption of an additional unit. It is expressed as:
Marginal Utility = Change in Total utility
Change in Quantity

Or

Marginal utility = TUn - TUn - 1

(iii) Average Utility : It refers to the utility that is obtained by the consumer per unit
of commodity consumed. It is expressed as:

Average Utility = Total utility (units of consumer goods)

Number of total units

Quantity Consumed Total Utility Marginal Utility Average Utility

1 20 - 20
2 35 15 17.5
3 47 12 15.6
4 55 8 13.75
5 60 5 12

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