Answer 1:
Introduction:
Indifference curve is graphical representation of a combined products that gives similar kind of
satisfaction to a consumer making them indifferent. Every point on the indifference curve shows that a
consumer is indifferent between the two products as it gives him the same kind of utility. For eg: a
consumer is given Apples and bananas at a given period of time
Indifference Curve Analysis:
The indifference curve analysis work on a simple graph having two-dimensional. Each individual axis
indicates a single type of economic goods. If the graph is on the curve or line, then it means that the
consumer has no preference for any goods, because all the good has the same level of satisfaction or
utility to the consumer. For instance, a child might be indifferent while having a toy, two comic books,
four toy trucks and a single comic book.
Indifference Curve Map:
The Indifference Map refers to a set of Indifference Curves that reflects an understanding and gives an
entire view of a consumer’s choices. The below diagram shows an indifference map with three
indifference curves.
Properties of indifference Curve:
Indifference Curves are Negatively Sloped:
The indifference curves must slope down from left to right. This means that an indifference curve is
negatively sloped. It slopes downward because 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.
In fig. 3.4 the two combinations of commodity cooking oil and commodity wheat is shown by the points
a and b on the same indifference curve. The consumer is indifferent towards points a and b as they
represent equal level of satisfaction.
At point (a) on the indifference curve, the consumer is satisfied with OE units of ghee and OD units of
wheat. He is equally satisfied with OF units of ghee and OK units of wheat shown by point b on the
indifference curve. It is only on the negatively sloped curve that different points representing different
combinations of goods X and Y give the same level of satisfaction to make the consumer indifferent.
(2) Higher Indifference Curve Represents Higher Level:
A higher indifference curve that lies above and to the right of another indifference curve represents a
higher level of satisfaction and combination on a lower indifference curve yields a lower satisfaction.
In other words, we can say that 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.
In this diagram (3.5) 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 Curve are Convex to the Origin:
This is an important property of indifference curves. They are convex to the origin (bowed inward). This
is equivalent to saying that as the consumer substitutes commodity X for commodity Y, the marginal
rate of substitution diminishes of X for Y along an indifference curve.
In this figure (3.6) as the consumer moves from A to B to C to D, the willingness to substitute good X for
good Y diminishes. This means that as the amount of good X is increased by equal amounts, that of good
Y diminishes by smaller amounts. The marginal rate of substitution of X for Y is the quantity of Y good
that the consumer is willing to give up to gain a marginal unit of good X. The slope of IC is negative. It is
convex to the origin.
(4) Indifference Curve Cannot Intersect Each Other:
Given the definition of indifference curve and the assumptions behind it, 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.
In fig 3.7, 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 show 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
(wheat) 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.
In fig. 3.8, it is shown that the in-difference IC touches Y axis at point C and X axis at point E. At point C,
the consumer purchase only OC commodity of rice and no commodity of wheat, similarly at point E, he
buys OE quantity of wheat and no amount of rice. Such indifference curves are against our basic
assumption. Our basic assumption is that the consumer buys two goods in combination.
Conclusion: A consumer always shows rational behavior when it comes to making choice between two
similar products.
Answer 2:
Introduction:
Price elasticity is a measure of how consumers react to the prices of products and services. In normal
circumstances demand is inversely propositional to prices means demand decreases when price
increases but depending on the product/service and the market, consumers behavior towards price
change can vary.
Definition:
The OECD (Organization for Economic Co-operation and Development) offers the following definition:
“The price elasticity in demand is defined as the percentage change in quantity demanded divided by
the percentage change in price.”
For Eg: if the price of tomato rises by 10% then the demand for tomato will go down by 10%.
Concepts and Applications:
Types of price Elasticity:
Types of Price Elasticity
Perfectly Relatively Relatively Unitary Elastic
Perfectly Elastic
Inelastic Elastic Demand inelastic Demand Demand
Demand
Demand
Perfectly Elastic:
Perfectly Elastic demand means a small change in price of a product causes a major change in its
demand. In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a small
fall in price causes increase in demand to infinity. In such a case, the demand is perfectly elastic or ep =
00.
In the below figure it can be seen that at price OP, demand is infinite. Demand will become zero with a
small change in price. Perfectly elastic demand cannot be applied in the real-world scenarios
Perfectly Inelastic Demand:
Perfectly inelastic demand is when there is no change in the demand of a product with change in its
price. The numerical value of perfectly inelastic demand is zero (ep=0).
As shown in the diagram below, the movement in price from OP1 to OP2 and OP2 to OP3 do not lead to
any change in the demand of a product (OQ). Perfectly inelastic demand cannot be applied in a practical
situation. But in case of essential goods, such as salt, the demand does not change with change in price.
Hence the demand for essential goods is perfectly inelastic.
`Relatively Elastic Demand:
Relatively elastic demand refers to the demand when the proportionate change produced in demand is
greater than the proportionate change in price of a product. The numerical value of relatively elastic
demand ranges between one to infinity.
As shown in the below diagram, the proportionate change in demand from OQ1 to OQ2 is relatively
larger than the proportionate change in price from OP1 to OP2. Relatively elastic demand has a practical
application as demand for many of products respond in the same manner with respect to change in their
prices.
Relatively Inelastic Demand:
Relatively inelastic demand is one when the percentage change produced in demand is less than the
percentage change in the price of a product. For example, if the price of a product increases by 30% and
the demand for the product decreases only by 10%, then the demand would be called relatively
inelastic. The numerical value of relatively elastic demand ranges between zero to one (ep<1). Marshall
has termed relatively inelastic demand as elasticity being less than unity.
As shown in the below diagram, the proportionate change in demand from OQ1 to OQ2 is relatively
smaller than the proportionate change in price from OP1 to OP2. Relatively inelastic demand has a
practical application as demand for many of products respond in the same manner with respect to
change in their prices
Unitary Elastic Demand:
When the proportionate change in demand produces the same change in the price of the product, the
demand is referred as unitary elastic demand. The numerical value for unitary elastic demand is equal to
one (ep=1).
As shown in the below diagram, change in price OP1 to OP2 produces the same change in demand from
OQ1 to OQ2. Therefore, the demand is unitary elastic.
Formula for Price Elasticity of Demand=
Percentage Change in in Quantity Demanded/percentage in price.
Where,
%Change in Quantity demanded =
New Quantity demanded- old quantity demanded*100/Old quantity demanded
%Change in price=
New Price – Old Price*100/Old Price
Solution to the problem:
Price (Rs.) Demand(units)
4 25
Let us assume the product to be X. As per the statement at Rs4, quantity demanded for X is 25 units.
Price of the X increased to Rs 5 which led to the decrease to Quantity and it fell up to 20 units.
Old Price= Rs 4
New Price= Rs 5
Old Quantity = 25 units
New Quantity= 20 units
%Change in price=
New Price – Old Price*100/Old Price
5-4*100/4=25%
%Change in Quantity demanded =
New Quantity demanded- old quantity demanded*100/Old quantity demanded
20-25*100/25
-500/25=20%
Price Elasticity of Demand=
Percentage Change in in Quantity Demanded/percentage in price.
-20%/25%=-0.8
Price Elasticity of demand is =-0.8.
Conclusion:
The above calculation shows the demand is slightly sensitive to price and inversely proportional to price
when the Price increase by Rs1, quantity demanded fell by 5 units. Similarly, if the price would have fell
by Rs1 then quantity demanded would have increased by 5 units up to 30.
Answer 3
Part A:
Introduction:
Cross Price Elasticity of Demand:
Cross Price Elasticity of Demand means how sensitive the demand for a product is to changes in the
price of another product.
Definition:
It is defined as an economic concept that measures the responsiveness in the quantity demanded of one
good when the price for another good changes. It is calculated by taking the percentage change in the
quantity demanded of one good and dividing it by the percentage change in the price of the other good.
Cross Elasticity of demand works in to scenarios:
Substitute Goods:
Goods which can be used in place of each other are known as substitute goods. These are also known as
the products that satisfies the same basic want as another product. In perfect competition where both
goods which are perfect substitutes to each other, an increase in the price of one goodwill led to an
increase in demand for the rival product. For example, if the price of coffee goes up people will move to
tea as tea is the perfect substitute for coffee. The cross-price elasticity for two substitutes will be
positive.
As shown in the below diagram, when the price for one product (Po) goes up the demand for its
substitute (Qc) good goes up.
Complimentary Goods:
Goods which are consumed or used jointly with another product are called Complementary goods. An
increase in the price of main good will lead to the decrease in the demand of its complimentary good as
it has to be consumed with the main good itself. Therefore, the cross elasticity for complimentary goods
is always negative. For e.g. If the price of coffee increases, the demand for coffee stir sticks drops as
consumers are drinking less coffee and need less sticks.
As shown in the below diagram, when the demand for one product (Do) increases then the demand for
its complimentary product (Da) also increases.
