BUSINESS ECONOMICS

1. The concept of Indifference curve has been by developed by Francis Y Edgeworth which can be
defined as the locus of points each representing a different combination of two substitutes, which
yield the same level of utility to a consumer. In simpler words it describes all of the points and
combinations of two goods which gives us the same utility.

For better understanding below is an indifference curve where the vertical axis. i.e., Y axis
shows the quantity in bars of chocolates and the horizontal axis i.e., X axis represents
the quantity of fruits in pounds. The graph below represents different combinations of the
goods which are preferred by the consumer. A consumer consumes different combination of the
two goods and realizes that one good can be substituted with another without compromising on
the satisfaction level. The line that connects the combination is called the indifference curve
which states the consumer is indifferent between the two.

Combination Units of chocolate Y Units of fruits X Utility

1 20 5 U
2 10 15 U
3 5 25 U

30

25

20

15

10

0
0 5 10 15 20 25

The properties of indifference curve are mentioned as below:

• Indifference curves are always convex to the origin

 It implies that as a consumer consumes more of one good he consumes less of the other good. It
happens because if the consumer decides to have more units of fruits, he will reduce the number of
chocolates so the total utility remains the same.

• Higher indifference curve represents higher levels of satisfaction

Higher indifference curve represents large bundle of goods which means more utility because of the
preference.

• Indifference curves can never intersect each other

As two indifference curves cannot represent the same level of satisfaction, they cannot
intersect each other. It means only one indifference curve will pass through a given point on an
indifference map.

2. Price elasticity of demand is a measure of a change in the quantity demanded of a product due
to the change in the price of the product in the market.

ep= price elasticity of the demand

P= initial price

P*= change in price

Q= initial quantity demanded

Q*= change in quantity demanded

Here,

P= 4

P1= 5

Q= 25

Q1= 20

Therefore, the change in the quantity of the good is:

Q*= 25-20= 5

The change in price

P*= 5-4= 1

Price elasticity of demand= Change in quantity/ Change in price X Initial price/ initial demand
 Ep= 5/ 1 X 4/ 25= 0.8

Thus, the price elasticity of demand of the good is 0.8

3.

A) The cross elasticity of demand can be defined as a measure of a proportionate change in the
demand for goods as a result of change in the price of related goods. In the words of
Ferguson” the cross elasticity of demand is the proportional change in the quantity
demanded of good X by the proportional change in the price of the related good Y.”

Cross elasticity= percentage change in quantity demanded of X / percentage change in price of Y

3a.a) Whenever the cross-elasticity demand is more than one such as in this case where it is
+1.2, this donates that the goods under consideration are substitute goods.

Substitute goods are those kinds of goods that can be used in the place of another. The price of one
good share a direct relationship with the demand for its substitute goods.

3a.b) When the price of one good rise by 5% keeping the price of its substitute good constant, the
demand for its substitute also rises. Whereas the demand for the good whose price had risen falls since
it has become costlier.

The rise or increase in the quantity demand of this other good= 1.2*5=6%

B) Marginal utility can be described as the change in the total utility attained from the
consumption of an additional unit of commodity.

Marginal utility= total utility n - total utility n –1

Quantity 1 = 20-0= 20

Quantity 2= 35-20= 15

Quantity 3= 47-35=12

Quantity 4= 55-47= 8

Quantity 5= 60-55= 5
 Average utility refers to the utility that is obtained by the consumer per unit of commodity
consumed. It is calculated by dividing the total utility by the number of units consumed.

Quantity 1= 20/1= 20

Quantity 2= 35/ 2= 17.5

Quantity 3= 47/3= 15.6

Quantity 4= 55/4= 13.75

Quantity 5= 60/5= 12

Thus,

Quantity consumed Total utility Marginal utility Average utility

1 20 20 20
2 35 15 17.5
3 47 12 15.67
4 55 8 13.75
5 60 5 12