Business Economics Assignment Answer Sheet

Question 1 Answer:
Introduction:
- Firstly Indifference curve is an ordinal utility approach.
- As per ordinal utility approach utility can be measured in terms of preferences, choices
and ranks or less than and greater than. For example one of consumer may choose pizza
over burger. So in this case pizza is having 1st preference by consumer over burger.
- As per this approach consumer can identify pair of two different commodities which
can give him / her equal level of satisfaction. And out of these two different
commodities he / she can choose one commodity over another as per his / her preference
of utility or level of satisfaction.
- By plotting these different pair of two commodities value on graph and by connecting
these all points we will get a curve which is known as Indifference curve. Indifference
curve has different properties and criticism.
- When more than one indifference curve is plotted on single graph, then it is called as
indifference map.
Concept of Indifference Curve and its Properties:
Any curve is a graphical representation of two different commodities.
- Definition: Indifference curve can be defined as it is a graphical representation showing
the combinations of two goods that give the consumer the same level of satisfaction
and utility, making him / her indifferent.
- Hence the consumer is indifferent to combination of two goods / commodity if he / she
has to choose out of them. Because a consumer can consumes a variety of goods over
time and can realise that one good can be substituted with another good without
sacrificing the level of satisfaction.
- Combination of goods by consumer can depends on many factors such as budget of
consumer, choice, preference, taste etc.
- When we plot these combinations on graph we will get a curve which is called as
indifference curve.
- Indifference curve is also called as iso-utility curve or equal utility curve.
- Indifference curve can be explained with the help of below example:
Let us consider an example of apple and orange as two different goods.
 In graph X-Axis represents apple & Y-Axis represents orange.
Combination Apples Oranges
A 1 22
B 2 14
C 3 10
D 4 8
E 5 7
  After plotting all the combinations on graph and connecting all points together we will
get curve as shown in below image which is called as indifference curve.

(Indifference curve for substitutes Apple & Orange)

 Point A on graph shows that consumer is equally satisfied by having 1 apple and 22
oranges, or 2 apples and 14 oranges for combination B or 3 apples and 10 oranges for
combination C etc.
 Therefore we can say consumer remains indifferent towards any combination of two
goods which is giving him / her equal level of satisfaction.
 While plotting indifference curve there are few criticism which are listed as below:
1. Ignorance towards market behaviour.
2. Only two commodities model on curve
3. Ignorance towards demonstration effect
4. Indifference towards risks and uncertainties
5. Unrealistic assumptions

Properties of Indifference Curve (IC):

1. ICs are negatively sloped
2. IC is convex to the origin
3. Higher IC represents higher satisfaction level
4. ICs do not intersect

1. ICs are negatively sloped:

The IC curve is sloped downward towards right hence it is negative in nature. This is
because the consumption of both commodities are inversely proportional to each other.
If one consumes the commodity X more he / she has to reduce consumption of
 commodity Y in order to maintain same level of satisfaction. Therefore ICs are
negatively sloped.

2. IC is convex to the origin:

This is one of the important property of the indifference curve. It is convex to the
origin. And it means we can say that the consumer willing to substitutes commodity X
for commodity Y, hence marginal rate of substitution diminishes of X for Y with the
indifference curve.
3. Higher IC represents higher satisfaction level:
In a graph if one IC lying above and towards right of another IC then it shows higher
level of satisfaction and vice versa. Each indifference curve has different level of
satisfaction. Lower IC represents lower level of satisfaction. Therefore we can say that
combination of two different commodities on higher IC is preferred by consumer than
the combination on lower IC.
4. ICs do not intersect:
We can show more than one IC on same graph but none of these IC intersect with each
other. This is because each indifference curve showing different combination of two
commodities which will give same level of satisfaction to the consumer.

Conclusion:
- It can be concluded that indifference curve plays an important role to analyse consumer
demand as it shows the combination of two different commodities which gives
consumer an equal level of satisfaction.
- Ordinal utility can be analysed by using Indifference curve.
- From indifference curve Marginal Rate of Substitution (MRS) can calculated which
means the rate at which one commodity can be substituted for another commodity to
maintain same level of satisfaction.
- Indifference curve is negatively sloped, convex to the origin & they do not intersect
with each other.
- Higher indifference curve means higher level of satisfaction.
Question 2 Answer:
Given Data:
- Original price of unit (P) = 4 Rs.
- Original quantity demanded (Q) =25 units
- New price of unit (P1) = 5 Rs.
- New quantity demanded (Q1) = 20 units
Therefore, change in price of unit is:

ʌP = P1 – P
ʌP = 5 – 4
ʌP = 1

Similarly, change in quantity demanded of unit is:

ʌQ = Q1 – Q
ʌQ = 20 – 25
ʌQ = - 5
In the above calculation, a change in demand shows a negative sign which is ignored. This is
because price and demand are inversely related which can yield a negative value of demand.

Price elasticity of demand is:

Formula:

ep = ʌQ / ʌP x P / Q

ep = 5/1 x 4/25
ep = 0.8
Final answer = The price elasticity is 0.8

Statement: The price elasticity of demand is 0.8 which is less than one. Therefore in such a
case the demand for unit is relatively inelastic.
Question 3(a) Answer:
Firstly,
Definition of Cross price Elasticity of Demand: As per 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.”
Hence, Cross Elasticity of Demand:
ec = (% change in quantity demanded of X) / (% change in price of Y)
There are three types of cross elasticity of demand as below:
1. Positive cross elasticity of demand
2. Negative cross elasticity of demand
3. Zero cross elasticity of demand
Now, the value of cross price elasticity of demand is given as +1.2.
From the value +1.2 it is Positive cross elasticity of demand. Which means when the price of
one product increases then there will be increase in demand of related product & vice versa.
Cross elasticity of demand is positive in case of substitute goods. Hence it is substitute goods.
It means increase in price of one product will increase demand of related product. For example
if the orange and apple are related products, and if the price of apple increases then people will
tend to buy more oranges as substitute to apple.
Cross elasticity of demand is negative in case of complementary goods. It means increase in
price of one product will decrease in demand of related product. Let’s take an example of
chicken, if the price of chicken increases then the demand of chicken masala will decrease.
Another example is if the price of butter increases then the demand of bread will decrease.
If the price of one good rises by 5% :
As it is positive cross elasticity of demand, increase in price of one good results in increase in
demand of other good. Hence if the price of one good increased by 5% then the demand of
other product will increase as below,
ec = Cross price elasticity of demand = +1.2

ʌQ = change in quantity

ʌP = change in price = 5% = 0.05

Q = Original quantity
P = original price = assume 1
Now,

ec = (ʌQ / ʌP) X (P / Q)

1.2 = (ʌQ / 0.05) X (1 / Q)

0.06 Q = ʌQ

ʌQ = 6%
Statement: from the above answer we can say that if the price of one goods increased by 5%
then there will be increase in demand of other related goods by 6%.

Question 3(b) Answer:

Given Data:
Quantity Consumed (n) Total Utility (TU)
1 20
2 35
3 47
4 55
5 60

Quantity consumed = n
Total utility = TU
To Calculate Marginal Utility:
Formula:
Marginal Utility = TUn – TU(n-1)
 Marginal Utility for 1st quantity consumed = TU1 – TU(1-1) = 20 – 0 = 20

 Marginal Utility for 2nd quantity consumed = TU2 – TU(2-1) = 35 – 20 = 15

 Marginal Utility for 3rd quantity consumed = TU3 – TU(3-1) = 47 – 35 = 12

 Marginal Utility for 4th quantity consumed = TU4 – TU(4-1) = 55 – 47 = 8

 Marginal Utility for 5th quantity consumed = TU5 – TU(5-1) = 60 – 55 = 5

To Calculate Average Utility:

Formula:
Average Utility = Total Utility / Quantity Consumed
 Average Utility for 1st quantity consumed = TU1 / n1 = 20/1 = 20
  Average Utility for 2nd quantity consumed = TU2 / n2 = 35/2 = 17.5

 Average Utility for 3rd quantity consumed = TU3 / n3 = 47/3 = 15.67

 Average Utility for 4th quantity consumed = TU4 / n4 = 55/4 = 13.75

 Average Utility for 5th quantity consumed = TU5 / n5 = 60/5 = 12

Final Answer:
Quantity Consumed Total Utility Marginal Utility Average Utility
1 20 20 20
2 35 15 17.5
3 47 12 16.67
4 55 8 13.75
5 60 5 12

From above answer, we can say that marginal & average utility decreases after every
additional consumption of unit.