BUSINESS ECONOMICS

Question 1:

Introduction:

An indifference curve is a collection of possible combinations of two items that provide the
customer with equal happiness. Because any combination gives the same amount of
satisfaction, a consumer is indifferent to the various combinations on the indifference curve.
As a result, the overall satisfaction or utility received from any of these combinations
remains constant. This curve is also known as iso-utility curve or equal utility curve.
Symbolically,

U0 = f(q1 , q2)

Where,

U0 = total utility that remains constant;

q1, q2 represent different combinations of two goods.

Concept and Application

An indifference curve is a graph that depicts all of the product combinations that provide the
same level of happiness to the consumer. The consumer enjoys all of the combinations
equally since they all provide the same level of enjoyment. As a result, the curve is known as
the Indifference Curve. The Indifference Curve is a well-known alternative to the marginal
utility analysis of demand. This is based on customer desire and the belief that human
satisfaction cannot be numerically measured in monetary terms. Rather of measuring
customer preferences in terms of money, this viewpoint assigns them a rank.

Let's look at this with the assistance of the indifference schedule, which displays all of the
combinations that give the customer equal satisfaction. Assume that consumer consumes two
commodities A (Apples) and B (Bananas) and makes five combinations for the two
commodities a,b,c,d, and e, which is shown in table 1.1:

Combinations of A (Apples) B (Bananas)

8
6 c
4
d
2
e
0
1 2 3 4 5 6
A (Apples)

Fig 1.1

Consumers are undecided between five apple and banana combinations, as shown in the
timetable. The utility of combination ‘a' (1A +15B) is the same as that of (2A+10B),
(3A+6B), and so on. We get an indifference curve  when these combinations are visually
depicted and linked together, as illustrated in Fig 1.1.

The customer is indifferent between the combinations a,b,c,d, and e since they all provide
equal satisfaction. Indifference Set refers to all of these combinations.

Indifference Map

The Indifference Map is a collection of indifference curves that indicate customer

Marginal Rate of Substitution (MRS)

MRS stands for the rate at which commodities may be replaced for one another without
affecting the consumer's overall pleasure. For example, in the preceding example of A
(Apples) and B (Bananas), the MRS of ‘A' and ‘B' will be the number of units of ‘B' that the
customer is ready to give up in exchange for an extra unit of ‘A' to retain the same level of
pleasure.

MRSAB= Units of B (Bananas) willing to Sacrifice

Units of A (Apples) willing to Gain

∆A

MRSAB is the rate at which a customer is ready to trade one more unit of Apple for one more
banana. MRS calculates the slope of the indifference curve. Table 1.2 explains what MRS AB
is and how it works.

Combination A (Apples) B (Bananas) MRSAB

a 1 15 -

b 2 10 5B:1A

c 3 6 4B:1A

d 4 3 3B:1A

e 5 1 2B:1A

Table 1.2

Consumer sacrifices 5 bananas for 1 apple while moving from a to b, as seen in the above
timetable. As a result, MRSAB is a 5:1 ratio. Similarly, MRSAB is 4:1 from b to c.
Combination e reduces the sacrifice to two bananas for one apple. To put it another way, the
MRS of apples for bananas is declining.

Assumptions of Indifference Curve

The following are the different indifference curve assumptions:

1. Two commodities: It is assumed that the customer has a certain amount of money that
must be spent entirely on the two items, with both goods' prices being constant.
2. Non-satisfaction: It is considered that the customer has not yet attained saturation.
Consumers always want more of both commodities, i.e., they try to climb up the
indifference curve in order to achieve greater and higher levels of satisfaction.
3. Ordinal Utility: A consumer's preferences can be ranked based on how satisfied he is
with each bundle of products.
4. Decreasing marginal rate of substitution: The marginal rate of substitution is supposed to
be decreasing. An indifference curve is convex to the origin because of this assumption.
5. Rational Customer: The consumer is considered to act rationally, with the goal of
maximizing overall pleasure.
Properties of Indifference Curve

1. 1. Indifference curves are downhill sloping and convex to the origin: Indifference
curves are slanted downwards to the right. The fundamental reason for this is that when a
consumer consumes more of commodity A, he or she must sacrifice some of commodity
B in order to retain the same degree of happiness. Because MRS decreases, an
indifference curve is convex to the origin. As the customer consumes more apples, his
marginal utility from apples decreases, and he is ready to give up less bananas in
exchange for each apple.
2. Indifference curves never overlap: Due to the rule of transitivity, two indifference
curves cannot reflect the same degree of satisfaction, i.e., they cannot intersect. It
indicates that on an indifference map, just one indifference curve will pass through a
particular location.
3. Higher indifference curves imply higher degrees of satisfaction: Because of
monotonic preference, a higher indifference curve represents a broader bundle of goods,
which equals more utility. A customer prefers the combination on the higher IC over the
combination on the lower IC.

Conclusion

Indifference curve analysis is a step forward in utility analysis because it attempts to address the
shortcomings of cardinal utility analysis and gives a technically superior demand analysis. The
characteristics of indifference curves offer information about customer preferences for different
bundles of commodities. Indifference curve analysis is a more advanced method of examining
customer behaviour. Indifference curves are helpful in the fields of production, distribution,
exchange, public finance, and international commerce, in addition to explaining consumer
equilibrium and surplus. However, it is predicated on a number of assumptions. An indifference
curve is a collection of possible combinations of two items that provide the customer with equal
happiness. The buyer is indifferent among the combinations on an indifference because they all
provide the similar level of enjoyment. An indifference map is a collection of indifference
curves. Each curve of indifference is a separate line. From left to right, it dips downhill. To the
origin, it is convex. There are certain exceptions, such as when an indifference curve is a straight
line or even concave to the origin in some rare circumstances. The X-axis and the Y-axis can
never be touched by an Indifference Curve: If the IC reaches the Y-axis, the consumption of the
commodity on the X-axis is zero. Similarly, if IC crosses the X-axis, it means that commodity
consumption on the Y-axis is zero. As a result, an IC cannot touch any of the axes.
Question 2:

The price elasticity of demand is a measurement of how a product's consumption changes in

Price elasticity of demand = Percentage change in quantity demanded

Percentage change in price

= ∆Q x 100

∆P x 100

Thus, the formula for calculating the price elasticity of 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

According to the question,

P= 4

∆P= 1 (5-4)

Q= 25

∆Q= 5 (25-20)

We may get the following result by inserting these numbers in the preceding formula:

ep= 5 × 4

1 25
 = 20

25

= 4

= 0.8

As a result, the price elasticity is 0.8, which is below 1. As a result, demand is quite inelastic.
Question 3 (a) :

Introduction:

The change in demand for a good X in response to a change in the price of a good Y is
referred to as cross-elasticity of demand. Cross-price elasticity of demand is another name for
it. Its scale is as follows:

Ed = % Change in Quantity Demanded of Good X

% Change in Price of Good Y

= Py x ∆Qx

Qx ∆Py

Where,

Py = Original price of good Y

∆Py = Change in price of good Y

Qx = Original quantity demanded of X

∆Qx = Change in the quantity demanded of X

Concept and Application:

(a) :

Because the cross elasticity of demand is +1.2, these commodities are substitutes, as demand
for one commodity rises as the price of the alternative rises. This is frequently due to
customers' constant desire to maximize utility. The more the perceived satisfaction, the less
they spend on anything.

For example, if the price of coffee rises, demand for tea (a replacement beverage) rises as
customers seek a less priced but equally substitutable alternative. This is represented in the
cross elasticity of demand formula, which shows positive increases in both the numerator
(change in tea demand) and denominator (price of coffee).

(b):

When the price of one product rises by 5%, demand for the other good rises as well. In this
situation, the cross elasticity of demand is positive, and the commodities are replacements for
one another. A 5% rise in demand for one item will result from a 6% increase in demand for
another one. Coffee and tea, for example, can be used interchangeably. When the price of
coffee rises, the demand for tea rises as well, since people drink less coffee and need to buy
 more tea. The numerator (tea quantity demand) is positive, while the denominator (coffee
price) is positive in the formula. As a result, the cross elasticity is positive.

Conclusion:

The cross elasticity of demand is an economic term that evaluates how sensitive a quantity
requested of one item is to changes in the price of another good. This statistic, also known as
cross-price elasticity of demand, is computed by dividing the percentage change in the amount
requested of one good by the percentage change in the price of the other good. The cross
elasticity of demand is an economic term that evaluates how sensitive a quantity requested of one
item is to changes in the price of another good. Because demand for one product rises as the
price of the substitute good rises, the cross elasticity of demand for substitute goods is always
positive. The cross elasticity of demand for complementary products, on the other hand, is
negative.
 Question 3(b):

The utility in which the total unit of consumption of products is divided by the number of
Total Units is known as Average Utility. Average Utility is the name given to the Quotient.
For instance, if the Total Utility of 4 bread is 40, the average utility of 3 bread is 12 if the
Total Utility of 3 bread is 36, i.e. (36 3 = 12).

Average Utility = Total Utility of the product

Total Units of the product

The utility obtained from the last or marginal unit of consumption is known as marginal
utility. It refers to the greater utility obtained by the customer from purchasing, acquiring, or
consuming an additional unit of a particular item. It is the usefulness of the additional or
extra units of the commodity in the overall stock that adds to total utility. It has been said—as
the final unit of a commodity's complete stock.

Marginal Utility = TUn – TUn-1

Where,

TUn = Total Utility obtained from all the n units of good X

TUn-1 = Total Utility obtained from n-1 units of good X

Quantity Total Utility Marginal Utility Average Utility

2 35 15 (35-20) 17.5 (35/2)

3 47 12 (47-35) 15.66 (47/3)

4 55 8 (55-47) 13.75 (55/4)

5 60 5 (60-55) 12 (60/5)