Course: Business Economics

Internal Assignment Applicable for June 2022 Examination

Answer 1

Introduction
The marginal rate of substitution (MRS) is that the willingness of a consumer to choose one
good over another, on the condition that both the products are equally satisfying. In other
words, marginal rate of substitution (MRS) refers to the rate at which one commodity may
be substituted for a different commodity maintaining the identical level of satisfaction.

There are some assumptions and limitations while calculating Marginal rate of Substitution.
They are as below:-

Assumptions
 The consumer is logical and knowledgeable to consume every unit of a product.
 Goods are equal in shape and size
 No time gap between consumption.
 No change in preference, income, taste, and fashion.
 Utility is cardinal.
 Marginal unit of money is constant.

Limitations- This law doesn’t apply to

 Dissimilar units.
 Unreasonable quantity.
 Unsuitable time period.
 Rare collections like coins, stamps etc.
 Change in fashion and preference of the consumer.
 Abnormal person.
 Changing the income of the consumer.
 Habitual goods.
 Durable and valuable goods.

Concepts and Application

The MRS for 2 substitute goods X and Y is also defined as quantity of commodity X
required to switch one unit of commodity Y (or quantity of commodity Y required to re-
place one unit of X) such the utility derived from either combinations remains identical. This
suggests that the utility of X (or Y) is adequate to the utility of additional units of Y (or X)
added to a mixture. MRS of X and Y is denoted as ∆Y/ ∆X because it continues to
diminish because the consumer continues to substitute X for Y or vice versa.

Combination Units of X Units of Y ΔX ΔY ΔX/ ΔY

A 25 3
B 20 5 -5 2 -2.5
C 16 10 -4 5 -0.8
D 13 18 -3 8 -0.375
E 11 28 -2 10 -0.2
As the consumer moves from combination a to b, he/she sacrifices 5 units of commodity X
and gets 2 units of commodity Y. Therefore

MRS x, y = –2.5

Similarly when the consumer moves from combination b to c, he/she sacrifices 4 units of X
and gets 5 units of Y. Therefore,

MRSx,y = –0.8

Some Features of Marginal Rate of Substitution is as below:-

 For most goods the marginal rate of substitution isn't constant so their indifference
curves are curved.
 The marginal rate of substitution between perfect substitutes is always constant.
 The marginal rate of substitution may be either zero or infinite.
 When the MRS is plotted graphically, it forms a slope within the Indifference Curve
and shows that because the consumer moves down the Indifference Curve from point
a to b to c and eventually to e, MRS diminishes from -2.5 to -0.2.
 The negative slope of the indifference curve denotes that the marginal rate of
substitution is often positive;

Conclusion
Hence, Marginal Rate of substitution forms an integral part of the indifference curve which is
refers to the collection of points each representing a singular combination of two substitutes,
which yield the identical level of utility to a consumer. Therefore, the customer is indifferent
to any combination of two commodities if he/she has to make a choice between them.
Answer 2
Introduction
Revenue is the total amount of money received by an organization in return of the goods sold
or services provided during a given time period. In other words revenue of a firm refers to the
money received by the firm from the sale of a given quantity of a commodity in the market.

There are three types of revenues which are:-

1. Total Revenue
2. Average Revenue
3. Marginal Revenue

Concepts and Application

Total Revenue
Total Revenue (TR) of a firm is defined as the total receipts of money from the sale of a
given quantity of a commodity. Total revenue is actually the total income of the firm. Total
Revenue is calculated by multiplying the quantity of the commodity sold and the price per
unit of the commodity.

Symbolically
Total Revenue = Quantity X Price

For example, if a firm sells 20 chocolates at a price of Rs 300 per book, then the total revenue
is calculated as:

20 chocolates X Rs 300 = Rs 6000 is the total revenue

Marginal Revenue
Marginal Revenue (MR) of a firm is defined as the revenue earned by selling an additional
unit of the commodity. In other words, the change in total revenue received from the sale of
an additional unit is called marginal revenue.

Symbolically
MRn = TRn – TRn-1

Where MRn= Marginal revenue of nth unit (Additional unit), TRn is the total revenue from
sale of n units and TRn-1 is the total revenue generated from sale of n-1 units. ‘n’ is the
number of units sold.

If we take the above example

N= 20 chocolates
Price= 300
TRn = Rs 6000/-
Now
n-1= 19
Price= 300
TRn-1= 5700

Therefore
MRn = TRn – TRn-1
MRn = 6000 – 5700= 300

Another method to calculate marginal revenue also exits.

As stated earlier, MRn is the change in TR when an extra unit is sold. However, when more
than one unit is sold, MR is calculated as per the below formula

Change in Total Revenue (ΔTR)

Change in Number of Units sold (ΔQ)

Therefore MR= ΔTR/ ΔQ

The same can be elaborated using an example.

Suppose the Total revenue from sale of 20 chocolates is Rs 6000 and the total revenue from
sale of 15 chocolates is Rs 4500, then marginal revenue will be calculated as :-

MR = (6000-4500)/(20-15)
= 1500/5
= 300

Relationship between Total Revenue and Marginal Revenue

Marginal revenue is that additional revenue collected from the sale of an additional unit of
output, expressed as follows:-

MR= ΔTR/ ΔQ

If a firm sells 20 chocolates at a price of Rs 300 per book, then the total revenue is calculated
as:

20 chocolates X Rs 300 = Rs 6000 is the total revenue

To increase sales, the firm needs to bring down the price. Now the price per book is Rs 250
and the firm sells 22 chocolates. Therefore Total revenue is Rs 5500 (22 chocolates X Rs
250)

In this case MR is calculated as

MR22 = (TR22 – TR20)/ (22- 20)
MR22 = (6000- 5500)/2
MR22 = 250
 If MR is greater than zero, the sale of that additional unit increases the TR
 If MR is below zero, the sale of additional unit decreases the TR
 If MR is zero, then the sale in additional unit doesn’t cause in change in TR.

These relationships exist between TR and MR as Marginal Revenue forms the slope of the
total revenue.

Below is the table wherein TR and MR needs to be calculated. The same is provided
Price Output (In units) Total Change in Change in Marginal
(A) (B) Revenue (C) Revenue (D) Units (E) Revenue (D/E)
20 1 20 0 0 0
18 2 36 16 1 16
16 3 48 12 1 12
14 4 56 8 1 8
12 5 60 4 1 4

Relationship between Average Revenue and Marginal Revenue

To understand the relationship between Marginal Revenue and Average Revenue, we need to
understand what Average Revenue is.

Average Revenue (AR) of a firm is defined as the revenue earned per unit of output sold. It is
calculated by dividing the total revenue of the firm by the total number of sold units.
Symbolically,
Average Revenue = Total Revenue/ Total number of units sold

Marginal revenue (MR) can be positive, zero or negative. On the other hand, AR denotes
price of a commodities which always remain positive.

Marginal Revenue can be less than average revenue (AR) for a firm selling an output in an
exceedingly monopolistic market, where one firm sells to many customers. A monopoly
market faces market control and includes a negatively-sloped demand curve. So as to sell
more units, a firm within the monopoly market must charge a cheaper price. The loss of
revenue on existing units is that the reason that marginal revenue is less than the
worth (AR) because the marginal revenue is a smaller amount than the total revenue, the
total revenue curve declines.

MR = AR occurs when a firm sells an output in a seamlessly competitive market, where there
are several buyers and several of a given product. In such a scenario, to withstand in the
market, firms sell products at the prevailing market price. Since, companies in a perfectly
competitive market have the same price for every unit (and additional units), the marginal
revenue is equal to the per unit price. The graph is a straight line.

Conclusion
Hence we can derive the relationship between Total Revenue, Average Revenue and
Marginal Revenue to guage the demand and preferences of consumers along with their
respective role in the different markets.
Answer 3.a

Introduction
The elasticity of demand represents degree of change in the quantity of a product demanded
in response to its determinants, like the price of the product, income of consumers and price
of substitutes.

Therefore, elasticity of demand is bi-furcated in three main categories, which are Income
elasticity of demand, Cross elasticity of demand and Price Elasticity of demand.

Procedure / Steps
Price elasticity of demand measures the change in the quantity demanded of a commodity
because of the change in the price of that commodity in the market.

It is expressed mathematically as:

Price elasticity of demand = Percentage change in quantity demanded /Percentage change in

price

Thus, the formula to calculate the price elasticity of demand is as below:

Ep = ΔQ/ ΔP X P/Q

Wherein
Ep = Price elasticity of demand = Initial price
ΔP = Change in price
Q = Initial quantity demanded
ΔQ = Change in quantity demanded

There are various types of Price Elasticity of demand are as follows:-

 Perfectly Elastic Demand- When a minor change (rise or fall) in the price of a product
results in a huge change (fall or rise) in the quantity demanded, it is known as
perfectly elastic demand and ep= ∞
 Perfectly Inelastic Demand- When a change (rise or fall) in the price of a product does
not lead to any change (fall or rise) in the quantity of the product demanded. In this
case, the elasticity of demand is zero and represented as ep = 0.
 Relatively Elastic Demand- When a change (fall or rise) in price of a product results
in bigger than the percentage or proportionate change (rise or fall) in quantity
demanded, the demand is referred to be relatively elastic demand. Therefore, elasticity
of demand, in this case, is greater than 1 and represented as ep > 1.
 Relatively Inelastic Demand- When a change (fall or rise) in price of a product results
in less than the percentage or proportionate change (rise or fall) in demand, the
demand is referred to be relatively inelastic demand and is represented as ep < 1
 Unitary Elastic Demand- Unitary elastic demand happens when a change (rise or fall)
in price results in equivalent change (fall or rise) in demand. The numerical value for
unitary elastic demand is one, i.e., ep =1

In the given question, we have to calculate the price elasticity of demand, which is as below:-
 Price of Air Quantity Demanded Change Change in Ep=
Ticket (Tickets per month) in Price Quantity P/q X
(Per Ticket) P Q ∆P ∆Q P/Q ∆Q/∆P ∆Q/∆P
1,00,000 5,000
1,20,000 3,500 20,000 -1,500 20 0.075 1.5

Conclusion
In the above calculation, a change in price is a negative sign, which is ignored as the same is
due to the inverse relationship existing between price and demand movement.

However, the price elasticity of demand for air ticket is 1.5, which is greater than one.
Therefore, it leads to the demand being relatively elastic.
Answer 3.b

Introduction
The elasticity of supply denotes the degree of change in the quantity supplied of a commodity
in response to the change in its pricing.

Mathematically, the elasticity of supply is denoted as:

Es = Percentage change in quantity supplied of commodity X

Percentage change in price of commodity X

Percentage change in quantity supplied = Change in quantity ∆S

Original quantity supplied S

Es= ∆S/S X P/∆P

Concepts and Application

The elasticity of supply is rarely the same under any circumstances. This is often because it is
simultaneously influenced by a number of factors. Some of the important factors that
influence the elasticity of supply are enlisted as below:-

a) Nature of the commodity- Product’s nature is an important factor that influences the
elasticity of supply
Perishable goods like fruits, vegetables, etc. that can’t be stored and therefore they are
relatively less elastic in supply.
Durable goods like furniture TV excetra have elastic supply as they can be stored and
the supplier can resort to change in pricing of the goods..

b) Time period- It impacts the elasticity of supply to a vast extent. Changes in prices
don’t affect the supply of products immediately. However, if the commodity price
remains high for an extended period of time, the supply of products is increased.
There are three types of period:
(i) Market Period or very short period
(ii) Short Period
(iii) Long Period

c) Technique of Production- Goods having simple technique and complicated technique

of production have elastic and inelastic supply respectively. If organizations use the
state-of-the-art techniques of production, the supply can be produced faster with
respect to the change in the price of products. If production is subject to the law of
diminishing cost and law of increasing cost, supply will be less elastic and elastic
respectively.

d) Agriculture products: The production of agriculture products cannot be increased or

decreased easily as they rely on natural factors, including weather conditions, rain,
 humidity, and sunlight. This affects the supply of such products to a huge extent;
thereby making the supply relatively inelastic.

Conclusion
Thus we have provided the list of factors which are important in determining the elasticity of
supply. There are also other factors, but, we have enumerated as per the requirement in the
question.