Module 1 - Introduction To Business Economics-1

BBA 1ST SEMESTER ECONOMICS FOR BUSINESS
Module 1: Introduction to Business Economics
Important definitions of economics

The word economics originates from the Greek words ‘oikos’ and ‘nomos’ which mean
household and management respectively. Economics deals with solving economic problems and
making decisions such as what to produce, how to produce and for whom to produce. These
economic problems give rise to the problem of choice, which arises because there are unlimited
resources and limited resources with alternative uses.
MODULE 1 is compiled by Prof. Divya A Reddy and vetted by Prof. Yashoda L. This material is for private
circulation for JU CMS only.
Major Economic Problems

If there is a central economic problem that is present across all countries, without any exception,
then it is the problem of scarcity. This problem arises because the resources of all types are
limited and have alternative uses. If the resources were unlimited or if a resource only had one
single use, then the economic problem would probably not arise. However, be it natural
productive resources or man-made capital/consumer goods or money or time, scarcity of
resources is the central problem.
What is an economic problem?
In view of the scarcity of means at our disposal and the multiplicity of ends we seek to achieve.
The economic problem lies in making the best possible use of our resources so as to get
maximum satisfaction in case of a consumer and maximum output or profit for a producer.
What are the fundamental Economic problems?
What to produce?
Resources are limited, we must choose between
different alternative collection of goods and services
that may be produced.
How to produce?
A choice must be made about the techniques of
production e.g labor intensive,capital intensive
For whom to produce?
It means that how various goods and services
produced are distributed in an economy. Ex:
domestic market, international markets etc.
Are the resources economically used?
No wastage or misutilization of resources since they
are limited
Problem to full employment?
Economy must endeavour to achieve full
employment not only of labour but of all its
resources
Problem of growth?
Economy must expand or develop and grow at a
steady rate in order to maintain conditions of
stability
Economics and decision making

Fundamentally all businesses are required to make decisions which can be categorised under
three categories. They are as follows
When it comes to making a rational choice with regard to allocation and utilisation of scare
resources, various kind of economic decisions are undertaken by business.
Kinds of economic decisions
• Production decisions: since the resources are limited producers should decide what to
produce (commercial goods or social goods) ; how to produce( to use capital intensive or
labour intensive techniques) and how much to produce( quantities based on price, inputs,
demand etc.)
• Exchange decisions: who is the target group of buyers for each product (whole sale or
retail, domestic or international) and at what prices?
• Consumption decisions: what to buy (based on taste and preferences) and how much to
buy (based on income, price, price of relative goods etc.)
Multidisciplinary nature of Economics

The study of Economics is divided into two parts on the basis of looking the system as whole
or in terms of its innumerable decision-making units. Microeconomics and Macroeconomics
are the two fundamentals streams of economics. Prof. Ragnar Frisch has classified economics
in to Microeconomics and Macroeconomics.
• Microeconomics: it deals with the behaviour of individual economics units such as
individuals, firms, buyers, sellers and so on. Therefore it is called the worm’s eye view of
the economy
• Macroeconomics: deals with aggregates of the economy at large such as national income,
general price index, total employment and unemployment, wage rate, money supply,
savings and so on. Therefore, it is called the bird’s eye view of the economy.
The difference between microeconomics and macroeconomics in a table format.

Aspect Microeconomics Macroeconomics
Focus Individual agents and small Aggregate economy and overall

economic units. economic trends.
Scope Study of individual consumer, Study of entire economy of a

firm, or industry. country or region.
Concern Allocation of resources and Economic growth, inflation,

decision-making. unemployment, etc.
Price Focuses on supply and demand Examines overall price levels in

Determination in specific markets. the economy.
Employment Focuses on individual firms' Analyses overall unemployment

hiring decisions. rates.
Consumption Analyses individual consumer Studies overall consumer

choices. spending patterns.
Production Studies production and output of Focuses on overall national

individual firms. production levels.
Economic Addresses microeconomic Addresses macroeconomic

Policies policy issues. policy decisions.
Examples Individual product pricing, Inflation rates, GDP growth,

labour markets. fiscal policy.
Microeconomics and macroeconomics are two essential branches of economics that analyse
economic behavior and trends at different levels. While microeconomics examines individual
economic agents like consumers and firms, macroeconomics looks at the broader economic
indicators of an entire economy. Understanding both aspects is crucial for a comprehensive
view of the economic landscape.
Economics as a discipline is versatile and multidisciplinary in nature. Apart from the

fundamental streams of economics i.e., microeconomics and macroeconomics, economics is a
multidisciplinary field that draws upon various disciplines to understand and analyse economic
phenomena. Its multidisciplinary nature allows economists to approach complex economic issues
from different perspectives and consider a wide range of factors that influence economic
behavior. Here are some key disciplines that contribute to the multidisciplinary nature of
economics:
o Mathematics and Statistics: Mathematics is fundamental to economic analysis, providing
the tools for modelling economic relationships, solving optimization problems, and
analysing data. Statistics, on the other hand, helps economists to gather, organize, and
interpret data, making empirical analysis a crucial aspect of economic research.
o Sociology: Economics often intersects with sociology to understand how social
institutions, cultural norms, and group behaviours impact economic decisions and
outcomes. Sociological insights are particularly valuable when studying topics like
income inequality, labour markets, and social welfare.
o Psychology: Behavioural economics is a subfield that incorporates principles from
psychology to explore how individuals' cognitive biases and emotions influence their
economic choices. Understanding human behavior helps economists create more realistic
models of decision-making.
o Political Science: The study of political institutions and government policies is essential
in understanding the role of governments in economic systems. Political decisions, such
as fiscal and monetary policies, can significantly affect economic outcomes.
o History: Economic history provides valuable lessons and context, allowing economists to
study past economic events and policies to inform present-day analysis. Historical
perspectives help economists understand the evolution of economic systems and
institutions.
Overall, the multidisciplinary nature of economics enables economists to approach economic

issues holistically, considering the interplay of various factors and disciplines to arrive at more
comprehensive and insightful analyses and policy recommendations. This interdisciplinary
approach is vital in understanding the complexities of real-world economic problems and finding
effective solutions.
Is economics Science or an Art?

In the field of economics, there has been an ongoing debate about whether it should be classified
as a science or an art. The answer to this question can vary depending on the perspective and
approach taken by economists.
Economics as a Science:
Many economists argue that economics should be considered a science. They emphasize the use
of empirical data, mathematical models, and rigorous analysis to understand economic
phenomena and make predictions. Economic theories and hypotheses can be tested through
observation and experimentation, akin to the scientific method. Econometrics, for example, is a
branch of economics that employs statistical techniques to quantify economic relationships and
test economic theories.
Economics as an Art:
On the other hand, some economists view economics as an art. They argue that economic
behavior is influenced by human psychology, social norms, cultural factors, and other intangible
elements that cannot be fully captured through quantitative methods alone. As a result, economic
policy and decision-making often require subjective judgment and creative thinking, which
aligns more closely with the artistic approach.
In reality, economics is a discipline that combines elements of both science and art. The scientific
aspect involves data analysis, hypothesis testing, and the development of economic models to
understand and predict economic behavior. At the same time, the artistic aspect comes into play
when economists interpret data, make policy recommendations, and consider the broader societal
impacts of economic choices.
Ultimately, understanding and addressing economic issues require a balanced approach that
draws upon both scientific methodologies and artistic insights. The interdisciplinary nature of
economics allows it to benefit from scientific rigor while acknowledging the complexities and
nuances inherent in human economic behavior.
Positive and normative nature of economics?

Positive economics deals with describing and explaining economic phenomena without
incorporating personal values or opinions, while normative economics involves making value-
based judgments and policy recommendations based on ethical or moral principles. Both
branches play an integral role in economic analysis and policymaking, with positive economics
serving as the building blocks for normative discussions.
Positive Economics:
Positive economics is the branch of economics that deals with objective, fact-based analysis. It
seeks to describe and explain economic phenomena as they are, without involving value
judgments or opinions. Positive economics is concerned with establishing cause-and-effect
relationships and making predictions based on empirical evidence and data. Economists in this
field use mathematical models, statistical analysis, and other scientific methods to test
hypotheses and derive conclusions about economic behavior.
The primary focus of positive economics is to answer questions like "What is?" or "What will
happen if...?" For example, economists might study the impact of a change in interest rates on
consumer spending or analyse how an increase in the minimum wage affects employment levels.
Positive economics aims to be objective and free from personal beliefs or biases.
Normative Economics:
Normative economics, on the other hand, is concerned with value judgments, opinions, and the
formulation of recommendations for economic policy. It deals with "what ought to be" or "what
should be" based on particular ethical or moral principles. Normative economics goes beyond
describing economic phenomena and attempts to offer prescriptions for how the economy should
function or how economic policies should be designed.
Normative statements in economics often involve subjective considerations and individual
values. For instance, debates about whether a government should implement a certain tax policy
to address income inequality or whether public spending on infrastructure projects should be
increased fall within the realm of normative economics.
It is crucial for economists to distinguish between positive and normative aspects of their
analysis to maintain objectivity and credibility. Positive economics provides the factual
foundation on which normative statements can be built. While economists can use their
understanding of positive economic principles to inform normative judgments, it is essential to
be transparent about the underlying assumptions and value judgments that influence normative
policy recommendations.
THEORY OF CONSUMER BEHAVIOUR

The study of microeconomics begins by examining the economic behaviour of the consumer.
Theory of consumer behaviour analyses the guiding force behind consumer decisions. The
concept of Utility and Utility analysis is the foundation of this theory.
Utility
Utility is the power of a commodity or service to satisfy human wants. Goods are desired
because of their ability to satisfy human wants. In economics, concept of utility is ethically
neutral. The terms utility and usefulness are different in meaning. A product may not be useful to
the consumer, however it may still have utility. For instance, cigarette smoking is injurious to
health but the consumer obtains utility from it. Utility is also different from satisfaction.
Satisfaction is the outcome of consumption of a product. However, utility is the cause for
consumption of a product.
Different Types of Utility:

In economics, production refers to the creation of utilities in several ways.
Thus, there are following types of utility:
1. Form Utility:
This utility is created by changing the form or shape of the materials. For example—A
cabinet turned out from steel furniture made of wood and so on. Basically, from utility is
created by the manufacturing of goods.
2. Place Utility:
This utility is created by transporting goods from one place to another. Thus, in
marketing goods from the factory to the market place, place utility is created. Similarly,
when food-grains are shifted from farms to the city market by the grain merchants, place
utility is created.
Transport services are basically involved in the creation of place utility. In retail trade or
distribution services too, place utility is created. Similarly, fisheries and mining also
imply the creation of place utility. Place utility of a commodity is always more in an area
of scarcity than in an area of scarcity than in an area of abundance e.g., Kashmir apples
are more popular and fetch higher prices in Pune than in Srinagar on account of such
place utility
3. Time Utility:
Storing, hoarding and preserving certain goods over a period of time may lead to the
creation of time utility for such goods e.g., by hoarding or storing food-grains at the time
of a bumper harvest and releasing their stocks for sale at the time of scarcity, traders
derive the advantage of time utility and thereby fetch higher prices for food-grains.
Utility of a commodity is always more at the time of scarcity. Trading essentially
involves the creation of time utility.
4. Service Utility:
This utility is created in rendering personal services to the customers by various
professionals, such as lawyers, doctors, teachers, bankers, actors etc..
Features of Utility
I. Utility is a subjective and a relative concept
II. Utility is a psychological concept
III. Utility must not be confused with usefulness
IV. Utility cannot be measured objectively.
V. Utility is distinct from satisfaction

VI. Utility is ethically neutral
CARDINAL APPROACH in consumer behaviour

Cardinal approach is also known as utility approach. According to this approach it is possible to
measure utility in cardinal numbers such as 1,2,3,4 etc.( cardinal numbers refer to those numbers
that can be added, subtracted , multiplied and compared. Professor Alfred Marshal is the chief
proponent of cardinal approach with his theory of Diminishing Marginal Utility.
Concepts of utility
Total utility: is the sum of the utility derived by a consumer from the various units of a good or a
service he/ she consumes at a point or over a period of time. Ex: if a consumer consumes 4
mangoes at a time then his total utility is
TUn= U1+ U2+ U3+ U4
Where TUn is total utility and U1, U2, U3,U4.. utility derived from consuming each unit of the
good(here Mango)
Marginal Utility(MU) : is the additional utility derived from consuming each additional unit of
the commodity. MU refers to change in the total Utility obtained from the consumption of an
additional unit of a commodity . It is expressed as
MUx= or MUx= TUn – TUn-1
Where, TUx = total utility , ΔQx = change in quantity consumed by one unit and MUx is the
Marginal utility
Kinds of Marginal Utility—Marginal utility is of three kinds:

(i) Positive Marginal Utility,
(ii) Zero Marginal Utility,
(iii) Negative Marginal Utility.
It is a matter of general experience that if a man is consuming a particular goods, then receiving
of next unit of goods reduces the utilities of the goods and ultimately a situation comes when the
utility given by the goods become zero and if the use of the goods still continues, then the next
unit will give dis-utility. In other words it can be said that we will derive “negative utility”.
This can be studied better by the following table:
Marginal Utility Table
From the table given above it is clear that up to the consumption of the fifth bread we receive
positive utility; 6th unit is the unit of full satisfaction i.e., Utility derive from that unit is zero.
From 7th unit the utility received will be negative utility. The table can be represented in shape
of diagram as follows: In diagram above, OX axis (line) shows unit of bread and OY line shows
the Marginal Utility received. From the figure it is clear that from the first unit of bread utility
received are 20 which has been shown on the top of the line.
Marginal Utility and Negative Utility

Similarly, 2, 3, 4, 5 Unit of bread’s utility is 16, 12, 8, 4 respectively All these have been shown
on OX line which shows positive marginal utility. Utility of the sixth bread is zero and that of the
seventh bread is negative and negative rectangle has been shown below OX line.
Zero Utility:
When the consumption of a unit of a commodity makes no addition to the total utility, then it is
the point of Zero Utility. In our table the total utility, after the 6th unit is consumed. This is the
point of Zero Utility. It is thus seen that the total utility is maximum when the Marginal Utility is
zero.
Negative Utility:
Negative Utility is that utility where if the consumption of a commodity is carried to excess, then
instead of giving any satisfaction, it may cause dis-satisfaction. The utility is such cases is
negative. In the table given above the marginal utility of the 7th unit is negative.
LAW OF DIMINISHING MARGINAL UTILTY
The law of diminishing marginal utility is one of the fundamental laws of economics. This law
states that as the quantity consumed of a commodity goes on increasing, the utility derived from
each successive unit goes on diminishing, consumption of all other commodities remaining the
same.
In simple words, when a person consumes more and more units of a commodity per unit of
time,eg. Icecream, keeping the consumption of all other commodities constant, the utility which
derives from each successive cup icecream goes on diminishing. This law applies to all kinds of
consumer goods durable and non- durable, sooner or later.
This is the premise on which buffet-style restaurants operate. They entice you with "all you can
eat," all the while knowing each additional plate of food provides less utility than the one before.
And despite their enticement, most people will eat only until the utility they derive from
additional food is slightly lower than the original.
For example, say you go to a buffet and the first plate of food you eat is very good. On a scale of
ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full
plate of food. Since you're not as hungry, your enjoyment rates at a seven at best. Most people
would stop before their utility drops even more, but say you go back to eat a third full plate of
food and your utility drops even more to a three. If you kept eating, you would eventually reach a
point at which your eating makes you sick, providing dissatisfaction, or "dis-utility.
Assumptions:
- All the units of a commodity must be same in all respects

- The unit of the good must be standard
- There should be no change in taste during the process of consumption
- There must be continuity in consumption
- There should be no change in the price of the substitute goods
Explanation:
As more and more quantity of a commodity is consumed, the intensity if desire decreases and
also the utility derived from the additional unit.
Suppose a person eats Bread. The 1st unit of bread gives him maximum satisfaction. When he
consumes 2nd slice bread his total satisfaction would increase. But the utility added by 2nd
bread(MU) is less then the 1st bread. His Total utility and marginal utility can be put in the form
of a following schedule.
Plotting the above data on a graph gives
• Here we see that TU curve is increasing or rising as the consumer eats more bread but at
decreasing rate( i.e. each extra slice of bread she eats the utility derived from that next
slice is declining) as MU is declining
• Here, from the MU curve we can see that MU is declining as consumer consumes more
of the commodity.
• When TU is maximum, MU is Zero.
• After that, TU starts declining and MU becomes negative.
Exceptions:
• The law is not applicable to rare collections. For example, collection of ancient coins,
stamps, antiques etc.
• The law is not fully applicable to money. The marginal utility of money declines with
richness but never falls to zero.
• It does not apply to knowledge, art and innovations,
• The law is not applicable to precious goods like diamonds, gold etc.
• The law does not operate if the consumer behaves in an irrational manner, ex: addicts
• The utility increases due to demonstration effect( a person tries to imitate his or her well
off neighbour is called demonstration effect)
Importance
• By purchasing more units of a commodity, the marginal utility decreases. Due to this
behaviour, the consumer cuts his expenditure on that commodity. It helps to utilise the
resources economically
• In the field of public finance , this law has a practical application as the principle of
taxation( imposing a heavier tax burden on the rich people) is based on this law
• This law is the base to other economic laws such as law of demand, elasticity of demand,
consumer surplus, the law of substitution etc.
• The theory of value is based on this law. The value of a commodity falls with an increase
in the supply of that commodity. This forms the basis for determining prices.
• Adam Smith explained the famous “diamond – water paradox” with the help of this law.
Diamond is relatively scarce. Therefore, it possesses high marginal utility and so a high
price.
• This law is the basis for the socialist plea for an equitable distribution of wealth. The
marginal utility of money to the rich is low. It is, therefore, advisable that the government
should acquire their surplus wealth and distribute to the poor, who possess high marginal
utility for money, by imposing direct taxes this method is called as progressive taxation. (
which is followed in India)
Relationship between Total utility and Marginal Utility

1. TU curve increases at a diminishing rate from the origin, reaches maximum and then
starts falling.
2. MU curve is the slope of TU curve since MUx=
3. When TU is maximum, called saturation point, MU is Zero.
4. After TU reaches maximum it does not rise further ; it starts falling
5. When TU falls, MU curve becomes negative.

6. The falling MU curve exhibits the Law of Diminishing Marginal Utility
Consumer Surplus
The essence of the concept of consumer’s surplus is that a consumer derives extra satisfaction
from the purchases he daily makes over the price he actually pays for them. In other words,
people generally get more utility from the consumption of goods than the price they actually pay
for them.
Thus, Marshall defines the consumer’s surplus in the following words: “excess of the price
which a consumer would be willing to pay rather than go without a thing over that which he
actually does pay is the economic measure of this surplus satisfaction…. it may be called
consumer’s surplus.”
The amount of money which a person is willing to pay for a good indicates the amount of utility
he derives from that good; the greater the amount of money he is willing to pay, the greater the
utility he obtains from it.
Therefore, the marginal utility of a unit of a good determines the price a consumer will be
prepared to pay for that unit. The total utility which a person gets from a good is given by the
sum of marginal utilities (IMU) of the units of a good purchased and the total price which he
actually pays is equal to the price per unit of the good multiplied by the number of units of it
purchased.
Consumer’s surplus is represented diagrammatically in figure DD is the demand curve for the
commodity. If OP is the price, OQ units of the commodity are purchased and the price paid is
OQ X OP= area OQRP. But the total amount of money, he is prepared to pay for OQ units is
OQRD. Therefore, Consumer’s Surplus= OQRD-OQRP=DPR.
Thus:
Consumer’s surplus = What a consumer is willing to pay minus what he actually pays.
Consumer Surplus = ∑ Marginal utility – (Price x Number of units of a commodity purchased)
The concept of consumer surplus is derived from the law of diminishing marginal utility. As we
purchase more units of a good, its marginal utility goes on diminishing. It is because of the
diminishing marginal utility that consumer’s willingness to pay for additional units of a
commodity declines as he has more units of the commodity.
The consumer is in equilibrium when marginal utility from a commodity becomes equal to its
given price. In other words, consumer purchases the number of units of a commodity at which
marginal utility is equal to price. This means that at the margin what a consumer will be willing
to pay (i.e., marginal utility) is equal to the price he actually pays.
Ordinal Approach or Indifference curve Analysis

In Microeconomics, the Indifference Curve Analysis is an important analytical tool in the study
of consumer behaviour. The indifference curve analysis was developed by the British economist
Francis Ysidro Edgeworth, Italian economist Vilfredo Pareto and others in the first part of the
20th century. J.R.Hicks & R.G.D. Allen in their research paper,' A Reconsideration of the Theory
of Value' criticized Marshallian cardinal approach of utility and propounded Indifference curve
theory of consumer's demand. It is also called as Ordinal Approach.
Concept of indifference curve
An indifference curve is a locus of combinations of goods which derive the same level of
satisfaction, so that the consumer is indifferent to any of the combination he consumes. If a
consumer equally prefers two product bundles, then the consumer is indifferent between the two
bundles. The consumer gets the same level of satisfaction (utility) from either bundle.
Graphically speaking, this is known as the indifference curve. An indifference curve shows
combinations of goods between which a person is indifferent.
This approach does not use cardinal values like 1, 2, 3, 4, etc. Rather, it makes use of ordinal
numbers like 1st, 2nd, 3rd, 4th, etc. which can be used only for ranking. It means, if the consumer
likes apple more than banana, then he will give 1st rank to apple and 2ndrank to banana. Such a
method of ranking the preferences is known as ‘ordinal utility approach’.
Table 2.5: Indifference Schedule

Combination
of Rice and Rice wheat
Wheat (A) (B)
P 1 15
Q 2 10
R 3 6
S 4 3
T 5 1
As seen in the schedule, consumer is indifferent between five combinations of Rice and wheat.
Combination ‘P’ (1A + 15B) gives the same utility as (2A + 10B), (3A + 6B) and so on. When
these combinations are represented graphically and joined together, we get an indifference curve
‘IC1’ as shown .
In the diagram, Rice is measured along the X-axis and Wheat on the Y-axis. All points (P, Q, R, S
and T) on the curve show different combinations of Rice and Wheat. These points are joined with
the help of a smooth curve, known as indifference curve (IC1). An indifference curve is the locus
of all the points, representing different combinations, that are equally satisfactory to the
consumer.
Every point on IC1, represents an equal amount of satisfaction to the consumer. So, the consumer
is said to be indifferent between the combinations located on Indifference Curve ‘IC 1’. The
combinations P, Q, R, S and T give equal satisfaction to the consumer and therefore he is
indifferent among them. These combinations are together known as ‘Indifference Set’.
Marginal Rate of Substitution (MRS):

MRS refers to the rate at which the commodities can be substituted with each other, so that total
satisfaction of the consumer remains the same. For example, in the example of apples (A) and
bananas (B), MRS of ‘A’ for ‘B’, will be number of units of ‘B’, that the consumer is willing to
sacrifice for an additional unit of ‘A’, so as to maintain the same level of satisfaction.
MRSAB = Units of wheat (B) willing to Sacrifice /

Rice Wheat Units of Rice (A) willing to Gain
Combination MRSAB
(A) (B)
P 1 15 – MRSAB = ∆B/∆A
Q 2 10 5B:1 A
R 3 6 4B:1A MRSAB is the rate at which a consumer is willing
S 4 3 3B:1A to give up wheat for one more unit of Rice. It
T 5 1 2B:1 A means, MRS measures the slope of indifference
curve.
MRS between Rice and Wheat
Principles of Diminishing Marginal Rate of Substitution of goods –
One of the basic postulates of ordinal utility theory is that Marginal rate of(MRS AB) decreases.
It means that the quantity of a commodity that a consumer is willing to sacrifice for an additional
unit of another commodity goes on decreasing. Law of diminishing Marginal rate of substitution
is an extensive form of the law of diminishing Marginal Utility. As discussed in previous section,
Law of diminishing marginal Utility states that as a consumer increases the consumption of a
good, his marginal utility goes on diminishing. Similarly as consumer gets more and more unit of
good A, he is willing to sacrifice less and less units of good B for each extra unit of A. The
significance of good A in terms of good B goes on diminishing with each addition of good A.
Properties of indifference curve
The main attributes or properties or characteristics of indifference curves are as follows:

1) Indifference Curves are Negatively Sloped:
The indifference curves must slope downward from left to right. As the consumer increases the
consumption of X commodity, he has to give up certain units of Y commodity in order to
maintain the same level of satisfaction.
(2) Higher Indifference Curve Represents Higher Level of Satisfaction:

Indifference curve that lies above and to the right of another indifference curve represents a
higher level of satisfaction. The combination of goods which lies on a higher indifference curve
will be preferred by a consumer to the combination which lies on a lower indifference curve.
Diagram:
In this diagram, there are three indifference curves, IC1, IC2 and IC3 which represents different
levels of satisfaction. The indifference curve IC3 shows greater amount of satisfaction and it
contains more of both goods than IC2 and IC1. IC3 > IC2> IC1.
(3) Indifference Curves are Convex to the Origin:
This is an important property of indifference curves. They are convex to the origin. As the
consumer substitutes commodity X for commodity Y, the marginal rate of substitution
diminishes as X for Y along an indifference curve. The Slope of the curve is referred as the
Marginal Rate of Substitution. The Marginal Rate of Substitution is the rate at which the
consumer must sacrifice units of one commodity to obtain one more unit of another commodity.
Diagram:
In the above diagram, as the consumer moves from A to B to C to D, the willingness to substitute
good X for good Y diminishes. The slope of IC is negative.In the above diagram, diminishing
MRSxy is depicted as the consumer is giving AF>BQ>CR units of Y for PB=QC=RD units of X.
Thus indifference curve is steeper towards the Y axis and gradual towards the X axis. It is
convex to the origin.
If the indifference curve is concave, MRSxy increases. It violets the fundamental feature of
consumer behaviour.
If commodities are almost perfect substitutes then MRSxy remains constant. In such cases the
indifference curve is a straight line at an angle of 45 degree with either axis.
If two commodities are perfect complements, the indifference curve will have a right angle.
In reality, commodities are not perfect substitutes or perfect complements to each other.
Therefore MRSxy usually diminishes.
(4) Indifference Curves cannot Intersect Each Other:
The indifference curves cannot intersect each other. It is because at the point of tangency, the
higher curve will give as much as of the two commodities as is given by the lower indifference
curve. This is absurd and impossible.
Diagram:
In the above diagram, two indifference curves are showing cutting each other at point B. The
combinations represented by points B and F given equal satisfaction to the consumer because
both lie on the same indifference curve IC2. Similarly the combinations shows by points B and E
on indifference curve IC1 give equal satisfaction top the consumer.
If combination F is equal to combination B in terms of satisfaction and combination E is equal to

combination B in satisfaction. It follows that the combination F will be equivalent to E in terms
of satisfaction. This conclusion looks quite funny because combination F on IC2 contains more
of good Y than combination which gives more satisfaction to the consumer. We, therefore,
conclude that indifference curves cannot cut each other.
5) Indifference Curves do not Touch the Horizontal or Vertical
Axis:
One of the basic assumptions of indifference curves is that the consumer purchases combinations
of different commodities. He is not supposed to purchase only one commodity. In that case
indifference curve will touch one axis. This violates the basic assumption of indifference curves.
Diagram:
In the above diagram, it is shown that the indifference IC touches Y axis at point P and X axis at
point S. At point C, the consumer purchase only OP commodity of Y good and no commodity of
X good, similarly at point S, he buys OS quantity of X good and no amount of Y good. Such
indifference curves are against our basic assumption. Our basic assumption is that the consumer
buys two goods in combination.
Ordinal Approach to Consumer Equilibrium

Definition: The Ordinal Approach to Consumer Equilibrium asserts that the consumer is said
to have attained equilibrium when he maximizes his total utility (satisfaction) for the given level
of his income and the existing prices of goods and services. To understand the equilibrium, we
need be clear with concept of Budget line or Budget Constraint
Budget Line
We know that the higher the indifference curve, the higher is the utility, and thus, utility
maximizing consumer will strive to reach the highest possible Indifference curve. But he has two
strong constraints: limited income and given the market price of goods and services. The
income in hand is the main constraint (budgetary) that decides how high a consumer can go on
the indifference map. In a two commodity model, the budgetary constraint can be expressed in
the form of the budget equation:
Px . Qx + Py . Qy =M
Where,
Px and Py are the prices of commodity X and Y and Qx, and Qy is their respective quantities.
M= consumer’s money income
The Budget equation states that the consumer’s expenditure on commodity X and Y cannot
exceed his money income (M).Consumer’s income is Rs 200
Price of
Combination of Rice Price of wheat(B)
rice(A) is Rs Money Income spent
and wheat is Rs 20 each kilo
40 each kilo
E 5 0 (5×40)+(0×20)= 200
F 4 2 (4×40)+(2×20)= 200
G 3 4 (3×40)+(4×20)= 200
H 2 6 (2×40)+(6×20)= 200
I 1 8 (1×40)+(8×20)= 200
J 0 10 (0×40)+(10×20)= 200
In the above diagram x axis represents rice and y axis represents wheat. At one extreme E the
consumer can buy 5 kilos of rice and the other extreme J he can buy 10 kilos of wheat. Between
E and J, there other combinations like F, G, H and I. By joining all these points we get a
downward sloping straight line called as budget line. Every point on the budget line indicates
those bundles of rice and wheat which consumer can purchase by spending the entire income of
RS. 200 at the given price of the goods.
SHIFT IN BUDGET LINE
Budget line is drawn on the basis of assumption of constant prices of the goods and constant
income of the consumer. Thus, if there is any change in either of the two variables, budget line
shifts.
Thus, there are two variables that causes shift in Budget Line:
1) Change in Income of the consumer
2) Change in equal proportion of Prices of both the goods.
1) Change in Income of the consumer

If income changes while the prices of goods remain the same, Budget line will shift rightwards
or leftwards. Since the prices of two goods are constant, slope of budget line will remain
constant.
The effect of changes in income on the budget line is shown in Figure. If consumer’s income
increases while prices of both goods X and Y remain unaltered, the price line shifts upward and
is parallel to the original budget line. This is because with the increased income the consumer is
able to purchase proportionately larger quantity of both goods than before.
On the other hand, if income of the consumer decreases, prices of both goods X and Y remaining
unchanged, the budget line shifts downward but remains parallel to the original price line. This is
because a lower income will leave the consumer in a position to buy proportionately smaller
quantities of both goods.
2) Changes in Price of either of the two goods:
Budget Line also shifts when there is change in price of either of the two goods. Increase in price
of any commodity reduces the purchasing power of the consumer, in turn reducing the quantity
demanded. Shift of Budget line due to change in prices of either good x or good y is presented
below:
o Changes in Budget Line as a Result of Changes in Price of Good X
Suppose, price of good X rises, the price of good Y and income remaining unaltered. With
higher price of good X, the consumer can purchase smaller quantity of X. In Figure, original
price line is AB. With increase in Price of good X, budget line will shift to AB2 i.e.
consumer will be able to buy less quantity of good X, quantity of good Y remaining same.
Similarly, when there is fall in price of good X, keeping prices of good Y constant, budget
line shifts from AB to AB1 i.e. consumer will be able to buy more quantity of good X,
quantity of good Y remaining same.
Shift in Budget line due to

change in price of good X
o Change in Price of good Y
The figure below shows the changes in the budget line when price of good Y falls or rises,
with the price of X and income remaining the same. It can be observed from Figure that the
initial budget line is AB. With fall in price of good Y, other things remaining unchanged, the
consumer could buy more of Y with the given money income and therefore budget line will
shift above to EB. Similarly, with the rise in price of Y, other things being constant, and the
budget line will shift below to DB.
Shift in Budget line due to change in

price of good Y
Consumer’s Equilibrium through Indifference Curve and Budget Line:
Consumer’s equilibrium is the point at which consumer attains maximum

satisfaction. A consumer is said to be in equilibrium when the budget line touc hes
indifference curve, with given price and income.
Assumptions are:
o Consumer is rational
o Income is constant – spends on 2 commodities.
o Prices of 2 commodities are given and constant
o Consumer seeks possible combinations based on scale of preference.
o Ceterus Paribus holds good ( All factors must remain unchanged)
o Homogenous and divisible goods
The consumer’s equilibrium through indifference curve and budget line
In Figure, there are three indifference curves IC1, IC2 and IC3. The budget line AB
is tangent to IC2 at point C. At this level, a consumer attains maximum satisfaction
level at OE units of good Y and OF units of good X. This is the first condition for the
consumer to be in equilibrium that indifference curve should touch the budget line.
The second condition is that the slope of budget line should be equal to the slope of
indifference curve.
Slope of budget line =Px/Py
Slope of indifference curve= ∆Y/∆X = MRSxy
Thus, when, Px/Py = MRSxy, the consumer achieves equilibrium. When these two
ratios become equal, the point of equality, when graphically represented will be the
point where the indifference curve touches the Budget line.
References
• Case Study: Inside the Electric Vehicle Market - Wharton Global Youth Program,
https://globalyouth.wharton.upenn.edu/articles/business/inside-the-electric-vehicle-
market/
• Case Study on Air fare hikes and pricing in
markets.https://economictimes.indiatimes.com/industry/transportation/airlines-/-
aviation/fare-turbulence-summer-travel-plans-scupper-in-vacuum-left-by-go-
first/articleshow/100700075.cms
• YouTube tutorial on Ordinal Approach https://youtu.be/iOmDo5jLFw8
• YouTube tutorial on Cardinal Approach https://youtu.be/1exopHOl1jo
• Xavier, V K.(2014).. Chapter 2 “Demand Analysis and consumer behaviour”. Economics
for Managers Pg 28-50, Magi’s Publication.

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BBA 1ST SEMESTER ECONOMICS FOR BUSINESS

Module 1: Introduction to Business Economics

Important definitions of economics

Major Economic Problems

Economics and decision making

Multidisciplinary nature of Economics

The difference between microeconomics and macroeconomics in a table format.

Focus Individual agents and small Aggregate economy and overall

Scope Study of individual consumer, Study of entire economy of a

Concern Allocation of resources and Economic growth, inflation,

Price Focuses on supply and demand Examines overall price levels in

Employment Focuses on individual firms' Analyses overall unemployment

Consumption Analyses individual consumer Studies overall consumer

Production Studies production and output of Focuses on overall national

Economic Addresses microeconomic Addresses macroeconomic

Examples Individual product pricing, Inflation rates, GDP growth,

Economics as a discipline is versatile and multidisciplinary in nature. Apart from the

Overall, the multidisciplinary nature of economics enables economists to approach economic

Is economics Science or an Art?

Positive and normative nature of economics?

THEORY OF CONSUMER BEHAVIOUR

Different Types of Utility:

Thus, there are following types of utility:

V. Utility is distinct from satisfaction

CARDINAL APPROACH in consumer behaviour

MUx= or MUx= TUn – TUn-1

Kinds of Marginal Utility—Marginal utility is of three kinds:

(ii) Zero Marginal Utility,

(iii) Negative Marginal Utility.

This can be studied better by the following table:

Marginal Utility Table

Marginal Utility and Negative Utility

- All the units of a commodity must be same in all respects

Plotting the above data on a graph gives

Relationship between Total utility and Marginal Utility

5. When TU falls, MU curve becomes negative.

Ordinal Approach or Indifference curve Analysis

Table 2.5: Indifference Schedule

Marginal Rate of Substitution (MRS):

MRSAB = Units of wheat (B) willing to Sacrifice /

Principles of Diminishing Marginal Rate of Substitution of goods –

Properties of indifference curve

The main attributes or properties or characteristics of indifference curves are as follows:

(2) Higher Indifference Curve Represents Higher Level of Satisfaction:

(3) Indifference Curves are Convex to the Origin:

If combination F is equal to combination B in terms of satisfaction and combination E is equal to

Ordinal Approach to Consumer Equilibrium

SHIFT IN BUDGET LINE

1) Change in Income of the consumer

2) Changes in Price of either of the two goods:

o Changes in Budget Line as a Result of Changes in Price of Good X

Shift in Budget line due to

o Change in Price of good Y

Shift in Budget line due to change in

Consumer’s Equilibrium through Indifference Curve and Budget Line:

Consumer’s equilibrium is the point at which consumer attains maximum

The consumer’s equilibrium through indifference curve and budget line

Slope of budget line =Px/Py

Slope of indifference curve= ∆Y/∆X = MRSxy

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