1) An indifference curve is defined as combination of two goods that give customer equal

satisfaction and utility therefore making customer indifferent. Since every merger of two
goods give the same height of utility, the customer is indifferent between any two
mergers of goods when it comes to making a choice between them. A customer is very
often confronted with such a situation in real life. The situation arises as customer needs
larger no. of goods and services and frequently finds that one commodity serves as
replacement of another. It gives individual a chance to replace one commodity for
another and to make numerous combinations of two substitutable goods. The customer
may tell which one of numerous combinations can be preferred.
It’s also possible for individual to tell which merger given more satisfaction. If a
customer is faced with same good mergers, he would be indifferent between the
combinations. When such combinations are plotted graphically, the resulting curve is
known as indifference curve or Iso-utility Curve or Equal Utility Curve.

For Example, Priya has 1 unit of food and 10 units of clothing. We ask Priya how much
unit of clothing she is ready to give in exchange of food so that her height of satisfaction
remain unchanged. Priya is ready to give 6 units of clothing for additional food hence we
have two combinations. The last column of the table shows an undefined utility (u)
derived from each combination of Food and clothing.

If combinations P, Q, R, S given in Table below are plotted and joined to form a smooth
curve, the resulting curve is known as indifference curve. On this curve, one can locate
many other points showing many other combinations of food and clothing which yield
the same satisfaction. Therefore, the consumer is indifferent between the different
combinations revealed by the indifference curve.

Indifference Schedule of Commodities X and Y

Combinatio Food Clothin Utility

n g
P 1 10 u
Q 2 6 u
R 3 5 u
S 4 3 u
 Indifference Curve

Properties of an indifference curve

a) Indifference curves never cross
Indifference curves could never cross. If cross this would result in creation of ambiguity as to
what the true utility is.
b) Indifference curves farther from origin rule
The farther the indifference curves lies, the farther is from origin and the greater the level of
utility designate. The farther from the origin the more utility customer generate while
consuming.

c) Indifference curves slope downward

Indifference curves slope download. The only way the consumer can gain consumption is
one good without gaining utility is to consume other goods and generate equal amount of
utility. Therefore, the slope is downward sloping.

d) Indifference curves assume convex shape

Indifference curves assume convex shape. As mentioned above, the curves get flatter as you
move down the curve to the right.

The indifference map shows the customers desire to buy any two goods. The budget line shows
his capacity to do so. Individual shows equilibrium when his need coincides with their capacity.
So, by putting the budget line and the indifference map in the same diagram we can determine
that combination of goods and services that the customer is both willing and able to purchase
2) In the words of Prof. Stonier and Hague, price elasticity of demand is a technical term
used by economists to explain measurement of change in consumption of a product in
relation to change in its price. Economist uses price elasticity to know how demand and
supply of product changes when price changes. Generally, the co-efficient of price
elasticity of demand always holds a negative sign because there is an inverse relation
between the price and quantity demanded.

Price elasticity of demand = Percentage change in quantity depended

Percentage change in price
Hence, formula for calculating price elasticity for demand is as follows: -

ep = ∆ 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

Given,

P = Rs. 4

∆ P = Rs.1 (Rs.5-Rs.4)

Q = 25 Units

∆ Q = -5 (20 units – 25 units)

In above calculation, the change in demand shows negative sign, which is ignored as
price and demand are inversely related which may hold negative value of demand.
 Now, we substitute these values in the formula of price elasticity of demand and the
calculation is given below:

ep = 5/1 * 4/25

=4/5

= 0.8

Price elasticity is 0.8.

3) A) It may be defined as the proportionate change in the demand of commodity as an

outcome to change the price of another related commodity. According to Ferguson,
“Cross Elasticity of demand is proportional change in the quantity demanded of good X
divided by proportional change in the price of related good Y”.

Ec = Percentage change in quantity demanded of X

Percentage change in the price of Y
The cross elasticity of demanded is stated as:
Ec = ∆Qx * Py
∆Py Qx

It is given that two goods have a cross-price elasticity of demand of +1.2. This states that the
goods are exactly substitutes because Cross elasticity of demand is positive in case of perfect
substitutes e.g. coffee and tea. High cross elasticity of demand exists for those products
which are perfect substitutes. In other words, if goods are perfect substitutes For example:
Bata or Lakhani Shoes, close up or Pepsodent tooth paste, Beans and ladies finger, Pepsi and
coca cola etc. The cross elasticity is zero when products are independent of each other. For
example, stainless steel, aluminum vessels etc. Cross elasticity between two goods is
negative when they are complementing goods. In these cases, rise in the price of one will
lead to fall in the quantity demanded of another commodity for example, car and petrol, pen
and ink etc.

Positive Cross Price Elasticity refers to gain in the price of a related product which is
responsible for gain in demand for main product or vice versa or occurs when the formula
produces a result greater than 0 or positive. That means that when the price of product X
increases, the demand for product Y also increases.
 For example, Burger King may increase the price of its products by 20 percent. In turn,
customers would prefer to go to Wendy’s as they may offer a cheaper meal. Consequently,
Burger King sees a rise in demand of 10 percent. This would suggest that there is a positive
relationship between the two.

For example:
Compare the demand of Burger King and Wendy’s. After deep consideration, Burger
King increases its price by 15 percent. Customers do not like the price increase and think
they are getting ripped off. Consequently, they switch to Wendy’s, thereby increasing
demand by 10 percent.

We need to remember the formula here:

Cross Price Elasticity = % Change in Demand of X / % Change in Price of Y

So the change in price goes at the bottom and the change in demand goes at the top.
Therefore, in this example:

Cross Price Elasticity = 10 percent increase in demand for Wendy’s

15 percent increase in prices for Burger King
= 10/15
= 0.67

This would indicate that the relationship between Burger King and Wendy’s is that of a
substitute good.
Therefore, as stated above we can say that if the price of one of the goods rises by 5 percent,
demand for the other good will increase, holding other factors constant.

3) B)

Calculation of Marginal Utility and Average Utility

Quantity Consumed Total Utility

0 0
1 20
2 35
3 47
4 55
5 60
Calculation of Marginal Utility
Marginal Utility = Change in Total Utility = TUn – TUn – 1
Change in Quantity
MU when quantity consumed is 1 = TU1 – TU1– 1 = 20 – 0 = 20
MU when quantity consumed is 2 = TU2 – TU2– 1 = 35 – 20 = 15
MU when quantity consumed is 3 = TU3 – TU3– 1 = 47 – 35 = 12
MU when quantity consumed is 4 = TU4 – TU4– 1 = 55 – 47 = 8
MU when quantity consumed is 5 = TU5 – TU5– 1 = 60 – 55 = 5

Quantity Consumed Total Marginal Utility

Utility
0 0 -
1 20 20
2 35 15
3 47 12
4 55 8
5 60 5

Calculation of Average Utility

Average Utility is that utility in which the total unit of consumption of resources is divided by
number of Total Units. The Quotient is known as Average Utility.

For example- If the Total Utility of 4 chocolates is 40, then the average utility of 3 chocolates
will be 12 if the Total Utility of 3 chocolates is 36 i.e., (36 ÷ 3 = 12).

Average Utility = Total Utility/Quantity consumed

Quantity Consumed Total Utility Average Utility

1 20 (20/1) = 20
2 35 (35/2) = 17.5
3 47 (47/3) = 15.66
4 55 (55/4) = 13.75
5 60 (60/5) = 12