BUSINESS ECONOMIS

(December-2021)
Answer 1.
Introduction:

An Indifference Curve (IC) is a diagrammatic presentation of an indifference set of

consumers, it is a locus of all such points which shows different combination of two
commodities (like apples & oranges) offering the same level of satisfaction of
consumer.
For example: when a consumer is spending his given income across goods A and B
(Good A be Apples and Good B be Oranges) and these goods are considered as
substitutes of each other.

Combination No. of Apples No. of Oranges

A 1 10
B 2 7
C 3 5
D 4 4
Different Combinations of Apples and Oranges

Observation:
(i) Combinations A, B, C, D are specified by the consumer according to his
scale of preferences for two goods.
(ii) Each combination offers same level of satisfaction to the consumer so,
combination A=B=C=D as per level of satisfaction
(iii) As there is no difference among combinations A,B,C,and D, the consumer
is indifferent across these combinations, these combinations form an
indifference set of the consumer.
Indifference set is a set of those combinations of two goods which offers the
consumer the same level of satisfaction, the consumer is indifferent across all
these above combinations.

Below diagram would you make better understand the concept described above:

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IC is an indifference curve. Each point on the curve shows a combination of two
goods, offering the same level of satisfaction to the consumer. thus, level of
satisfaction of the consumer at point A is the same as at point B, C and D.
Each point on the curve(like A,B,C….) shows one combination of two goods (apples
and oranges). Since each combination offers the same level of satisfaction to a
consumer, this curve is called indifference curve.

Properties of Indifference Curves:

Principal properties of indifference curves.

(i) Indifference Curves Slopes Downward

Indifferences Curves slopes downward from left to right. It means that IC

has a negative slope. It implies that if the consumer decides to have more
of one good, he must have less of the other. At point A on the IC, the
consumer has 5 oranges and 2 apples. Moving from A to B, he has 3
apples (one more than before) and 3 oranges (2 less than before). More of
one good must be combined with less of the other, this is due to IC
analysis assumes that the consumer has monotonic preference: when the
consumer moves from point A to B, and he has 3 apples instead of 2, his
satisfaction level from apples must rise.
Since A=B, in terms of satisfaction level, he must consume less of
oranges, so that the rise in satisfaction level (due to higher consumption of
apples) is counter balanced by the fall in satisfaction level which is due to
lower consumption of oranges.

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 (ii) IC is Convex to the Origin

This means that the slope of IC tends to decline, as we move along the IC
from left to right. The slope of IC from left to right. The slope of IC declines
because the rate at which
the consumer substitutes one commodity for the other tends to decline. It
is called ‘diminishing MRS (marginal rate of substitution), IC is convex to
the origin because MRS tends to decline.
MRS refers to the rate at which the consumer is willing to sacrifice Good Y
(on Y-axis) for Good-X (on X-axis). Between point A and B, the consumers
willing to give up 1.5 units of Good- Y for 1 more unit of Good-X, so that
MRS = ∆𝑌 =-1.5 = -1.5.
∆𝑋 1
When the curves move down from points B and C, the consumer is willing
to give up 1.5 units of Good-Y for 2 more units of Good-X, so that MRS =
∆𝑌 =-1.5 = -0.75.
∆𝑋
1
Similarly, points C and D, MRS will be -0.25, it is because of the
diminishing MRS that IC is convex to origin.

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 (iii) Higher IC shows Higher Level of Satisfaction

Higher IC indicates the higher level of satisfaction, IC4 indicates higher

level of satisfaction than IC3: IC3 indicates higher level of satisfaction than
IC2 ,IC2 indicates higher level of satisfaction than IC1. Each IC in the
indifference map corresponds to different level of consumer’s income.
Higher IC corresponds to higher level of income.

IC needs not to be parallel to each other, and also IC never touch or

intersect each other.

(iv) ICs do not Touch or Intersect Each Other

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 AS per the above diagram considering points A and B. These are on the same
IC1. These are equal in terms of level of satisfaction, so that A=B. likewise A=C,
as these are on the same IC2. Since A=B and A=C, B and C, the consumption of
Good-Y is the same (=OK). But at C, the consumption of Good-X (=KC) is greater
than at B (=KB). Implying that C must be offering higher level of satisfaction than
B.

(V) ICs do not Touch X-axis or Y-axis

• This is because IC analysis considers the consumption of two goods. If
IC touches Y-axis, it would mean that the consumption of Good-X is
zero.
• If IC touches X-axis, it would mean that the consumption of Good-Y is
zero.

This is all about Indifference Curve, related to it is explanation and it’s properties, all
points are been described briefly.

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Answer 2.
Introduction:

Price elasticity of demand is a measure of the responsiveness of the demand for a

good to change its prices, it is a measure of how consumers react to the price of
products and services. The more responsive the demand for a good is to it’s price,
the higher is the price elasticity of a demand for the good.

Demand for a commodity is always expressed with references to price. At higher

price quantity demanded will be low, and a lower price quantity demanded will be
high.

Concept:

Degree of change in quantity demanded (or the degree of extension and contraction)
in response to change in own price of the commodity is the subject matter of
elasticity of demand.
In elasticity of demand is a measurement of the degree of change in demand in
response to a given change in own price of the commodity, it is important while
measuring he degree of change in demand percentage values needs to be consider
instead of absolute values.
Price Elasticity of demand 𝐸𝑑 may be defined as a measurement of percentage
change in quantity demanded in response to given percentage change in own price
of commodity.
At some price, the percentage change in demand for a good is less than the
percentage change in the prices, then |𝐸𝑑 |< 1, and demand for the good is said to be
inelastic at that price.
At some price, the percentage change in demand for a good is equal to the
percentage change in the price, then |𝐸𝑑 |=1, and demand for the good is said to be
unitary elastic at the price.
At some price, the percentage change in demand for a good is greater than the
percentage change in the price then |𝐸𝑑 |>1, and demand for the good is said to be
elastic at that price.

Measurement of Price Elasticity:

There are two important methods of measuring price elasticity:

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 1) Percentage change method / Proportionate method

It is the most popular method of measuring price elasticity of demand under

this method,
Elasticity of demand is measured by the ratio of the proportionate percentage
change in quantity demanded to the proportionate percentage change in
price.

𝐸𝑑 = (-) Proportionate change in quantity demanded

Proportionate change in price

= (-) Change in Demand

Initial Demand X 100
Change in Price
Initial Price
• 𝐸𝑑 = Price elasticity of demand .
• Use of negative(-) sign use as prefix.

2) Geometric Method

This method measures price elasticity of demand at different points on the

demand at different curves, it is also called Point Method of measuring
elasticity, it is to use this method only with a reference to a linear demand
curve.

M (Upper segment)

P
(Lower segment)

O N X

Estimation of price elasticity of demand using Geometric method, whereas

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 • MN is a straight-line demand curve sloping downward, Point (P) can be
taken anywhere in the demand curve it divides the demand curve into
two segments, lower
segments which is (PN) and upper segments which is (PM)

• 𝐸𝑑 at point P = lower segment = PN

upper segment PM

In the above diagram, MN is a straight-line demand curve. The point is

a specific point on the demand curve. The point P divides the
demanded curve into two segments, lower segments = PN and upper
segments = PM.

Elasticity of demand at point P is estimated as the ratio between lower

segments (PN) and
upper segments (PM).

• 𝐸𝑑 at point P = PN (Lower segments from P)

PM (Upper segments from P)

NUMERICAL :

At price Rs 4, the demand for the good is 25 units. Suppose price of the good
increases to Rs 5, so by using Percentage change method the price elasticity would
be:

PRICE QUANTIY OF GOODS

4 25
5 20

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FORMULA

𝐸𝑑 = (-) Proportionate change in quantity demanded

Proportionate change in price

= (-) Change in Demand

Initial Demand X 100
Change in Price
Initial Price

P= 4; P1= 5; ∆P = P1-P = 5-4= 1

Q= 25 units; Q1= 20units ∆Q = Q1-Q = 20-25 = (-)5 units

Price elasticity of demand 𝐸𝑑 = (-) P × ∆Q

Q ∆P

=(-) 4 × -5
25 1

So, after this calculation the Price Elasticity is 4/5 or 0.80.

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Answer 3. (A)

The Cross Price Elasticity of demand is refers to the change quantity demanded of
one good when the price for another good changes By calculating cross price
elasticity, it can be determined if the products are substitutes, complements, or are
not related to each other. There is a formula for calculating it,

E(xy) = Percentage change in Quantity of X

Percentage change in Price of Y

By this formula , following can be deduced:

If E>0, then the products are substitutes of each other (like Tea & Coffee)
If E<0, then the products are complimentary of each other (like Tea & Biscuit)
If E=0, then the products are not related to each other.

Properties

• The cross elasticity of demand is an economic concept that measures the

responsiveness in the quantity demanded of one good when the price for
another good changes.
• The cross elasticity of demand for substitute goods is always positive
because the demand for one good increases when the price for the substitute
good increases.
• The cross elasticity of demand for complementary goods is negative.

Substitute Goods

Substitute Goods are refers to an increase in the price of one product will
lead to an increase in demand for the competing product.

Example: An increase in the price of petrol will forces consumer to go for

diesel and increase in the demand for diesel, if the related product is a weak
substitute, then the demand will be less cross elastic, but positive.

Complementary Good

Complementary Goods refers to those product or services that adds value to

another. In other words, they are two goods that the consumer uses together
to bring the right balance.

Example: DVD and a DVD Player, Tea and Biscuits, Tennis Balls and Tennis
Rackets or Mobile and Sim Cards

Conclusion

(a)If the Cross Price elasticity of Demand of +1.2, so the goods are
Substitutes to each other because the value of cross price elasticity is greater

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 than 0 and as we have described above If E>0, then the products are
substitutes of each other

Example: Tea & Coffee, if the price of Tea increases will lead to an increase
in demand for Coffee then consumers will go for Coffee.

(b) if the price of one goods rises by 5 percent, when other factors remains
constant and the impact on demand we need to find out so simply we put
values to cross price elasticity of demand formula which is
E(xy) = Percentage change in Quantity of X
Percentage change in Price of Y

So, we have the Cross Price Elasticity of Demand which is E(xy) = +1.2
And the Percentage change in Price is 5% or 0.05 where, ∆𝑄 denotes
Percentage change in Quantity of X.

After putting all in orders

+1.2 = ∆𝑄
0.05 ,

∆𝑄 = 1.2 ×0.05

∆𝑄 = 0.06 or 6%

So, the Percentage change in demand ∆𝑄 = 6%

Answer 3. (B)

Concept of Utility
Consumption of goods and services leads of satisfaction of human wants, when you
consume a cup of milk, and you can get some satisfaction, this satisfaction is called
‘Utility’. It is said to be the want satisfying power of a commodity.

Total Utility, Marginal Utility and Average Utility

Total Utility (TU): It is the sum total of utility derived from the consumption of all the
units of a commodity, for example: If 2 units of a commodity are consumed and 1 st
unit yields satisfaction of 10 utils, while the 2nd unit yields satisfaction of 9 utils, then
total utility = 10+9 utils = 19 units of utility.
Marginal Utility (MU) : It refers to additional utility on account of the consumption of
an additional units of a commodity, If 10 units of a commodity yield satisfaction of
100 utils, and 11 units of a commodity yield satisfaction of 105 utils, then additional

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utility on account of the consumption of 11th unit of commodity is 105 utils-100 utils =
5utils, This is called marginal utility.
Formula: MU(n)= TU(n) – TU(n-1)
For example: Mr. Piyush is consuming bread and he takes five breads. By taking first
unit he derives utility up to 20; second unit 16; third unit 12; fourth unit 8 and from
fifth 2. In this example the marginal unit is fifth bread and the marginal utility derived
is 2. If we will consume only four bread then the marginal unit will be fourth bread
and utility will be 8.
Average Utility (AU) :
Average Utility is defined as the utility derived from the use of one unit of commodity.
It is calculated by dividing the total number of utils by the number of units commodity
is used by the consumer. Average Utility is that utility in which the total unit of
consumption of goods is divided by number of Total Units.

Average Utility = Total Utility of the product

Total Units of the product

NUMERICAL :

As per the given information in the table:

Quantity Consumed Total Utility
1 20
2 35
3 47
4 55
5 60

Firstly we will figure out the values of Marginal Utility by using a formula:

Symbolically,
MU = ∆𝑇𝑈 where, MU = Marginal utility, Q = Units of Quantity
∆𝑄 TU = Total utility

MU1 = TU1-TU0 = 20-0 = 20

MU2 = TU2-TU1 = 35-20 = 15
MU3 = TU3-TU2 = 47-35 = 12

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 MU4 = TU4-TU3 = 55-47 = 8
MU5 = TU5-TU4 = 60-55 = 5, these are values for all MU as per given
information

Values of Average Utility by using a formula:

Symbolically,
AU = TU/Q where, AU = Average Utility,
TU = Total Utility
Q = Units of Quantity

AU= TU/Q = 20/1 = 20

AU = TU/Q = 35/2= 17.5
AU = TU/Q= 47/3= 15.6
AU= TU/Q = 55/4= 13.75
AU= TU/Q = 60/5= 12, these are values for all AU

Following solution can be seen in the table below

Quantity Total Utility Marginal Utility Average Utility

Consumed
1 20 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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