Eco Assignment

Q: 1:
a)
In defining substitution effect, the substitution effect tells the consumption of coffee keeping
the income constant. So initially we are at point (A) optimal, due to substitution between coffee

S.E Income effect

And bus rides the optimal point shifted from point A to another point (C) on same indifference
curve. In this case the income remained constant, just the preference is changing from more of
bus rides to more of coffee. To substitute we must stay on same indifference curve and so we r
on same indifference curve when substituting. In income effect the whole indifference shifted
to upwards right. This happened because due to fall in price of coffee, we want to consume
more of coffee now as compare to bus8 rides. Due to fall in prices of coffee our real income
increased. The shift to point B shows the income effect as shown by arrows.
b) Coffee is a normal good, because as our real income increased due to fall in price of coffee,
so we started consuming more coffee as compare to bus rides.
c) At the optimal point B there is tangent line B1 to indifference curve C1. At this point the slope
of indifference curve is equal to slope of tangent budget line. To find MRS the (The slope of
indifference curve) we take ratio of Rise over run.
So it will be
MRS = 2/1.4 almost nearly at point B

Q: 2:

a)

i) T.C = FC + VC ii) AFC = FC/Q iii) AVC = VC/Q iv) ATC = TC/Q

v) MC = Change in TC / Change in Q

Table 1
Cups FC VC TC AFC AVC ATC MC
of
coffee
0 0 10,000 10000 0 10k N/A
11200-
10000/100
100 10000 1,200 1200+10000= 10000/100 12 112 12
11200 =
100 12200-
11200/100
200 10000 2,200 2200+10000= 10000/200 11 61 10
12200 =
50 13100-
12200/100
300 10000 3,100 3100+10000= 10000/300 10.33 43.667 9
13100 =
33.33 14200-
13100/100
400 10000 4,200 4200+10000= 10000/400 10.5 35.5 11
14200 =
25 15500-
14200/100
500 10000 5,500 5500+10000= 10000/500 11 31 13
15500 =
20 17100-
 600 10000 7,100 7100+10000= 10000/600 11.833 28.5 15500/100
17100 = 16
16.6667 19100-
17100/100
700 10000 9,100 9100+10000= 10000/700 13 27.258 20
19100 =
14.2857
b) The efficient scale of output will be where the MC is minimum. So between 200 and 300 the
MC came down to 9 minimum.
But if we are part of competitive market so we must produce where ATC intersects MC which is
none of these points in the table.