2nd PUC Economics Question Bank Chapter 2 Theory of Consumer Behaviour

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Karnataka 2nd PUC Economics Question Bank Chapter 2 Theory of Consumer Behaviour

2nd PUC Economics Theory of Consumer Behaviour One Mark Questions and Answers

1. Choose The Correct Answer.

Question 1.
Utility is …………….
(a) Objective
(b) Subjective
(c) Both a & b
(d) None of the above
Answer:
(b) Subjective

Question 2.
The shape of an indifference curve is normaly…………….
(a) Convex to the origin
(b) Concave to the origin
(c) Horizontal
(d) Vertical
Answer:
(b) Concave to the origin

Question 3.
The consumption bundles that are available to the consumer depend on…………….
(a) Colour & Shape
(b) Price & Income
(c) Income & Quality
(d) None of the above
Answer:
(b) Price & Income

Question 4.
The equation of budget line is…………….
(a) Px + P₁x₁ = M
(b) M = P₀x₀ + Px
(c) P₁x₁ + P₂x₂ = M
(d) Y = Mx+C
Answer:
(c) P₁x₁ + P₂x₂ = M

Question 5.
The demand for these goods increases as income increases…………….
(a) Inferior goods
(b) Giffen goods
(c) Normal goods
(d) None of the above
Answer:
(c) Normal goods

Question 6.
A vertical demand curve is…………….
(a) Perfectly Elastic
(b) Perfectly inelastic
(c) Unitary Elastic
(d) None of the above
Answer:
(b) Perfectly inelastic

Question 7.
Ordinal Utility analysis expresses utility in …………….
(a) Numbers
(b) Returns
(c) Ranks
(d) Awards
Answer:
(c) Ranks

Question 8.
Any statement about demand for a good is considered complete only when the following is/are mentioned in it
(a) Price of the good
(b) Quantity of the good
(c) Period of time
(d) All of the above.
Answer:
(d) All of the above.

Question 9.
A situation of excess demand prevails at a :
(a) price lower than the equilibrium price.
(b) price higher than the equilibrium price.
(c) price equal than the equilibrium price.
(d) none of the above.
Answer:
(a)price lower than the equilibrium price.

Question 10.
When there is a rise in the price of a substitute good, the demand for the given good:
(a) increases
(b) decreases
(c) remains constant
(d) none of the above
Answer:
(a)increases

Question 11.
If Marginal rate of substitution is constant throughout, the indifference curve will be:
(a) Parallel to the x-axis
(b) Downward sloping concave
(c) Downward sloping convex
(d) Downward sloping straight line.
Answer:
(d) Downward sloping straight line.

Question 12.
The slope of indifference curve is measured by
(a) Marginal rate of transformation
(b) Marginal rate of substitution
(c) Marginal Opportunity cost
(d) None of the above
Answer:
(b) Marginal rate of substitution

Question 13.
When demand for one commodity does not change even if its price changes then its demand curve is
(a) flatter
(b) steeper
(c) parallel to Y-axis
(d) parallel to X-axis
Answer:
(c) parallel to Y-axis

Question 14.
Utility approach is ________.
(a) Cardinal
(b) Ordinal
(c) Both cardinal and ordinal
(d) None of the above
Answer:
(c) Both cardinal and ordinal

Question 15.
If price of sugar increases, the demand for tea will _______
(a) Decrease
(b) Increase
(c) not affected
(d) none of these
Answer:
(a) Decrease

Question 16.
Expansion and contraction in demand are caused by
(a) Change in the income of buyer
(b) Change in the taste and preference of the buyer
(c) Change in the price of the commodity
(d) Change in the prices of related goods.
Answer:
(c) Change n the price of the commodity

Question 17.
The consumer is in equilibrium at a point where the budget line
(a) Is above an IC
(b) Is below an IC
(c) Is tangent to an 1C
(d) Cuts an IC
Answer:
(c) Is tangent to an IC

Question 18.
The second apple gives lesser satisfaction to a hungry boy. this is a clear case of
(a) Law of Demand
(b) Law of Supply
(c) Law of Diminishing Marginal Utility
(d) Law of variable proportions
Answer:
(c) Law of Diminishing Marginal Utility

Question 19.
Which of the following pairs of goods is an example of substitutes?
(a) Tea and sugar
(b) Tea and coffee
(c) Pen and Ink
(d) Shirt and trousers.
Answer:
(b) Tea and coffee

Question 20.
All of the following items are determinants of demand except:
(a) Tastes and preference
(b) Quantity supplied
(c) Income
(d) Price of related goods.
Answer:
(b) Quantity supplied

Question 21.
Demand for a commodity refers to
(a) desire for the commodity
(b) need for the commodity
(c) quantity demanded of that commodity
(d) quantity of the commodity demanded at a certain price during any particular period of time
Answer:
(d) quantity of the commodity demanded at a certain price during any particular period of time

Question 22.
Which of the following pairs of goods is an example of substitutes?
(a) Tea and sugar.
(b) Tea and coffee
(c) Pen and ink
(d) Shirt and trousers.
Answer:
(b) price of a good and the quantity demanded

Question 23.
The law of demand, assuming other things to remain constant, establishes the relationship between
(a) income of the consumer and the quantity of a good demanded by him
(b) price of a good and the quantity demanded
(c) price of a good and the demand for its substitute.
(d) quantity demanded of a good and the relative prices of its complementary goods.
Answer:
(b) Tea and coffee

Question 24.
Suppose the price of Pepsi increases, we will expect the demand curve of coca cola to
(a) shift towards left
(b) shift towards right
(c) initially shift towards left and then to right
(d) remain at the same level.
Answer:
(b) shift towards right

Question 25.
The price elasticity of demand is defined as the responsiveness of
(a) price to change in quantity demanded.
(b) quantity demanded to a change in price
(c) price to a change in income.
(d) quantity demanded to a change in income.
Answer:
(b) quantity demanded to a change in price

Question 26.
The consumer is in equilibrium at a point where the budget line
(a) is above an indifference curve
(b) is below an indifference curve
(c) is tangent to an indifference curve
(d) cuts an indifference curve
Answer:
(c) is tangent to an indifference curve

Question 27.
The second glass of water gives lesser satisfaction to a thirsty boy. This is a clear case of
(a) a law of demand
(b) Law of diminishing returns
(c) Law of diminishing marginal utility
(d) Law of supply
Answer:
(c) Law of diminishing marginal utility

Question 28.
If, as people’s income increases, the quantity demanded of a good decreases, the good is called
(a) a substitute
(b) a normal good
(c) an inferior good
(d) a complement
Answer:
(c) an inferior good

Question 29.
Potato chips and popcorn are substitutes. A rise in the price of potato chips will _________ the demand for popcorn and the quantity of popcorn will_________
(a) increase; increase
(b) increase; decrease
(c) decrease; decrease
(d) decrease; increase
Answer:
(a) increase; increase

Question 30.
Total Utility derived from consumption of commodity will begin to fall_________.
(a) with every additional unit consumed
(b) when total utility curve becomes fiat
(c) when Marginal Utility starts falling
(d) when Marginal utility becomes negative
Answer:
(d)When Marginal Utility becomes negative

Question 31.
_________ curve is a downward sloping curve cutting the x-axis.
(a] Marginal Utility
(b) Total Utility
(c) Average Utility
(d) Both (a) and (c)
Answer:
(a) Marginal Utility

Question 32.
A consumer buys two commodities X and Y, he would be in equilibrium when _________.

Answer:
(a) MU = MU

Question 33.
The ratio of exchange between two goods on an indifference curve analysis is shown by the
(a) constant Marginal Rate of Substitution
(b) Indifference Curve
(c) increasing return to scale
(d) income consumption curve
Answer:
(a) MRS

Question 34.
Indifference curves can be a straight line at
(a) constant Marginal Rate of Substiruuon
(b) increasing Marginal Rate olSubstitutlon
(c) increasing return to scale
(d) None nf the above
Answer:
(a) constant Marginal Rate of Substitution

Question 35.
If the price of any complementary good rises,then
(a) demand curve shifts to left
(b) demand curve shifts to right
(c) demind curve moves downward
(d) demand curve moves upward
Answer:
(a) demand curve shifts to left

Question 36.
The demand function of a product x is given as D_x = 30-4P, where P is the price of the product. The demand at price of ₹ 4 will be
(a) 20
(b) 12
(c) 14
(d) 10
Answer:
(c) 14

Question 37.
If demand is parallel to X-axis, what will be the nature of elasticity?
(a) perfectly elastic
(b) inelastic
(c) Elastic
(d) Highly elastic
Answer:
(a) Perfectly elastic

II. Fill in the Blanks

1. Want satisfying capacity of a commodity is ______.
Answer:
Utility

2. Two indifference curves never ______ each other
Answer:
Intersects

3. As income increases, the demand curve for normal goods shifts towards ______
Answer:
Rightward

4. The demand for a good moves in the ______ direction of its price.
Answer:
Opposite

5. Method of adding two individual demand curve is called ______
Answer:
Horizontal summation

6. An equation xy = C gives us ______ hyperbola
Answer:
Rectangular

7. When demand for one commodity falls due to fall in price of the other good, the two goods are called as ____________ goods.
Answer:
Substitute

8. The vertical demand curve will show the good is ____________
Answer:
Perfectly Inelastic.

9. The relationship between price of commodity and demand of its substitute good is ____________
Answer:
Direct

10. ____________ Curve is a downward sloping curve cutting the X-axis.
Answer:
MarginaI Utility

11. Higher Indifference curve indicates ____________ level of satisfaction.
Answer:
Higher

12. Total utility is maximum when marginal utility is ____________
Answer:
Zero

13. If due to fall in the price of good X, demand for good Y rises, the two goods are ____________
Answer:
Complements

14. A ____________ set is a collection of all bundles available to a consumer at the prevailing market price at
a given level of income.
Answer:
Budget

15. ____________ is a locus of different combinations of two commodities which the consumer consumes
and whose cost is exactly equals to his income.
Answer:
Budget line

16. “A rational consumer prefers more of the commodity that offers him a higher level of satisfaction” hence it is called ____________
Answer:
Monotonic preferences.

17. As the consumer’s income increases, the quantity demanded for good increases and as the consumer’s income decreases, the quantity demanded decreases for a good, these goods are called as ____________ .
Answer:
Normal goods.

18. ____________ refers to the quantity of a good that a consumer purchases in a market at a particular price,
at a particular time.
Answer:
Demand

19. ____________ is the aggregate of quantities demanded by all individuals’ consumers in the market at different prices during a given period of time,
Answer:
Market Demand

20. ____________ means the want-satisfying power of a good or a service.
Answer:
Utility

21. A group of indifference curves for two commodities showing different levels of satisfaction is called ____________.
Answer:
Indifference Map

22. The Law of Diminishing Marginal Utility was introduced by the ____________ .
Answer:
German Economist Gossen.

23. ____________ refers to the quantity of a good that a consumer purchases in a market at a particular price, at a particular time.
Answer:
Demand

24. ____________ is the method of adding two individual demand curves horizontally.
Answer:
Market Demand

25. The responsiveness of demand to a change in one of its determinants, while other determinants remain
constant is called as ____________
Answer:
Elasticity of demand

26. When the price of a good decreases and the quantity demanded increases then it is called as ____________ .
Answer:
Expansion of demand.

27. When the price of a good increases and the quantity demanded decreases then it is called as ____________.
Answer:
Contraction of demand.

III. Match the following

Question 1.

Answer:
1. (b) Down ward sloping
2. (a) d(P) = a – bp
3. (e) |ed| = 1
4. (c) Pen & ink
5. (d) A family of indifference curve

Question 2.

A	B
1. MRS	a. 1f Consumers income increases, Demand for goods decrease
2. Utility	b. Tea and Sugar
3. Law of Demand	c. Marginal Rate of Substitution
4. Normal goods	d. Tea and Coffee
5. Inferior goods	e. Ceteris Paribus
6. Substitutes	f. If consumers income increases, demand for good also decreases
7. Complementary	g. Want satisfying power

Answer:

1. (c) Marginal Rate of Substitution
2. (g) Want satisfying power
3. (e) Ceteris Paribus
4. (f) If consumers income increases, demand for good also decreases
5. (a) If Consumers income increases, Demand for goods decrease
6. (d) Tea and Coffee
7. (b) Tea and Sugar

IV. Answer the following questions in a sentence/word.

Question 1.
What is budget line?
Answer:
Budget line is a locus of different combinations of two commodities which the consumer consumes and whose cost is exactly equals to his income.

Question 2.
What do you mean by cardinal Utility Analysis?
Answer:
It refers to the method where the utility can be measured with the help of cardinal numbers such as 1, 2, 3, etc. Cardinal numbers refer to those numbers that can be added, subtracted or multiplied.

Question 3.
Give the meaning of marginal utility?
Answer:
Marginal utility is the change in total utility due to consumption of one additional unit of a commodity.

Question 4.
What, is utility?
Answer:
Utility means the want-satisfying power of a good or a service.

Question 5.
Expand MRS.
Answer:
Marginal rate of substitution

Question 6.
What do you mean by Indifference curve?
Answer:
“Indifference cure shows the different combinations of two commodities in which consumers get equal level of satisfaction “.

Question 7.
What is demand?
Answer:
Demand refers to the quantity of a good that a consumer purchases in a market at a particular price, at a particular time.

2nd PUC Economics Theory of Consumer Behaviour Two Marks Questions and Answers

V. Answer the following Questions in 4 Sentences.

Question 1.
What is MRS?
Answer:
Marginal Rate of Substitution is the rate at which the consumer will substitute bananas for mangoes, so that his/her total utility remains constant. So, MRS = | ∆Y / ∆X |.

Question 2.
What are the differences between budget line & budget set?
Answer:
Budget Set :
The budget set is the collection of all bundles that the consumer can buy with her income at the prevailing market prices.

Budget Line :
The line consists of all bundles which cost exactly equal to money. This line is called the budget line.

Question 3.
What do you mean by inferior goods? Give example?
Answer:
These are the goods for which the demand is inversely related to consumer’s income. The demand for inferior goods decreases in response to increase in income and vice-versa, e.g. Cereals, toned milk, etc

Question 4.
What is monotonic preference?
Answer:
“A rational consumer prefers more of the commodity that offers him a higher level of satisfaction” hence it is called Monotonic preferences.

Question 5.
State the law of demand.
Answer:
The law of demand states that, “Other things remaining constant (Ceteris Paribus), when the price of a good decreases, the quantity demanded increases for the good, and when the price of a good increases, the quantity demanded decreases for the good.

Question 6.
Mention two different approaches which explain consumer behaviour.
Answer:
The two approaches which explains about consumer behaviour are

1. Cardinal Utility Analysis
2. Ordinal Utility Analysis

Question 7.
What do you mean by price elasticity of demand?
Answer:
It is a measure of the responsiveness of the demand for a good to change in its price, that is, changes in the quantity demanded with respect to changes in the price.

Where, p = actual price, q = actual quantity, ∆p = change in price, ∆q = change in quantity

2nd PUC Economics Theory of Consumer Behaviour Four Marks Questions and Answers

VI. Answer the following Questions in 12 Sentences.

Question 1.
Write the differences between Total utility & Marginal utility.
Answer:
Total Utility :

1. Total utility of a fixed quantity of a commodity is the total satisfaction derived from consuming the given amount of some commodity x.
2. TU depends on the quantity of the commodity consumed.
3. TU_x = ΣMU_x
   Where, TU = Total Utility, MU = Marginal Utility and x = commodity

Marginal Utility

1. Marginal utility is the change in total utility due to consumption of one additional unit of a commodity.
2. MU depends on the additional units of the commodity consumed.
3. MU_n = TU_n -TU_n-1
   Where, n refers to the nth unity of the commodity.

Question 2.
Briefly explain the budget set with the help of a diagram.
Answer:
Suppose the income of the consumer is M and the prices of bananas and mangoes are p₁ and p₂ respectively. If the consumer wants to buy x₁ quantities of bananas then he / she will have to spend P₁X₁ amount of money.
Similarly, if the consumer wants to buy x₂ quantities of mangoes, he/she have to spend p₂ x₂ amount of money.

Therefore, if the consumer wants to buy the bundle consisting of x₁ quantities of bananas and x₂ quantities of mangoes, he/she will have to spend p₁ x₁+ p₂ x₂ amount of money.

The set of bundles available to the consumer is called budget set. The budget set is thus the collection of all bundles that the consumer can buy with his/her income at the prevailing market prices. Example: Suppose, a consumer who has Rs. 20, and suppose, both the goods are prices at Rs. 5 and are available only in integral units. The bundles that this consumer can afford to buy are:

In the above diagram, on OX axis we measure Bananas and on OY axis we measure Mangoes. Any point in the diagram represents a bundle of the two goods. The budget set consists of all points on or below the straight line having the equation p₁ x₁ + p₂ x₂ = M

Question 3.
Explain the derivation of slope of the budget line
Answer:
The slope of the budget line measures the amount of change in mangoes required per unit of change in bananas along the budget line.
Consider any two points (x₁, x₂) and (x₁ + ∆x₁ x₂ + ∆x₂ on the budget line.
It must be the case that P₁x₁ + p₂x₂ = M and, P₁(x₁ + ∆x₁) + p₂ x₂ + ∆x₂) = M by subtracting both the equation, we get p₁∆X₁ + P₂ + p₂∆X₂= 0
By rearranging terms in the above equation, we get
∆X₂ / ∆X₁ = -P₁/P₂

Question 4.
Explain the indifference map with a diagram
Answer:
The consumer’s preferences over all the bundles can be represented by a family of indifference curves as showing the diagram. This is called an indifference map of the consumer.
All the points on an indifference curve represent bundles which are considered indifferent by the consumer.

A rational consumer always prefers more of the commodity that offers him a higher level of satisfaction. It is called ‘Monotonic Preferences’.

In the above diagram, on OX axis we measure Bananas and on OY axis we measure Mangoes. IC₁ IC₂, IC₃ are indifference curves of a consumer where it shows different levels of satisfaction.

The arrow indicates that bundles on the higher indifference curves are preferred by the consumer to
to the bundles on lower indifference curves

Question 5.
Write the difference between substitutes and complements.
Substitutes

1. Goods which are used as alternatives to satisfy a particular need are called substitute goods.
2. Examples: Goods like tea and coffee are not consumed together. But, they are substitutes for each other.
3. The demand for a good moves in the opposite direction of the price of its complementary goods.
4. When the price of a good increases, the demand for its complementary good decreases.

Complements

1. Goods which are consumed together are called complementary goods.
2. Examples: tea and sugar, shoes and socks, pen and ink, bike and petrol, etc.
3. The demand for a good usually moves in the direction of the price of its substitutes.
4. When the price of a good increases, the demand for its substitute good also increases.

Question 6.
Explain the differences between normal and inferior goods with examples.
Answer:
Normal Goods

1. Goods for which the consumer’s demand increases, as his/her income increases and demand decreases as the income decreases. Such goods are called normal goods.
2. Examples: Most of the daily-use goods such as vegetables, fruits, cloth etc.
3. A consumer’s demand for a normal good moves in the same direction as the income of the consumer.

Inferior Goods

1. Goods for which the consumer’s demand decreases, as his / her income increases, and demand increases as the income decreases. Such goods are called inferior goods.
2. Example: Pearl millet (sajje), finger millet [ragi], fox tail millet (navane), etc.
3. A consumer’s demand for a inferior good moves in the opposite direction as the income of the consumer.

Question 7.
Consider a market where there are just two consumers and suppose their demands for the good are given as follows

Answer:

Question 8.
Explain with the help of a numerical example, the meaning of diminishing marginal rate of substitution (MRS).
Answer:
The law of diminishing marginal rate of substitution states that as good 1 is substituted for good 2, the marginal rate of substitution of good 1 for good 2 goes on diminishing, for e.g.

The example shows the different combination of good 1 and good 2 that gives equal satisfaction to the consumer. Now in order to procure an additional unit of good 1 he is prepared to give up 4 units of good 2, hence MRS will be 4:1.

2nd PUC Economics Theory of Consumer Behaviour Six Marks Questions and Answers

VI. Answer the following questions in 20 Sentences.

Question 1.
Explain the law of diminishing marginal utility with the help of a table and diagram.
Answer:
Statement of Law: According to this law, “as consumer increases the consumption of any one commodity keeping constant consumption of all other commodities, the marginal utility of the variable commodity must eventually decline.”

Explanation of the law:
The law can be explained with the help of an example. A college girl comes home and she started drinking water to quench her thirst. First glass of water gives her a great utility. When she drinks second glass of water, the extent of her thirst should have reduced. Therefore, she will derive less utility from the second glass of water. If she takes the third glass the utility will be less than that of second glass. In this way, the additional utility from the extra glass of water will go on decreasing.

If she continues to take more glass of water, the marginal utility falls to zero and then becomes negative.
The above example can be illustrated with the help of schedule and diagram.

Table of total utility and marginal utility:


The above table represents, the consumer derives 12 units of utility from the first glass of water, when water is consumed continuously, the marginal utility falls to 4 units for the fourth glass of water and becomes zero for the fifth glass of water. The marginal utility becomes negative for the sixth glass.

The total utility goes on increasing at a decreasing rate and after a stage, begins to decline. When the marginal utility is zero, the total utility is constant and reachers the maximum. When the marginal utility becomes negative the total utility declines from 30 units to 28 units.

The above diagram depicts that, on OX axis we measure quantity of water, and on OY axis we ‘ measure utility. TU is total utility curve and MU is marginal utility curve. The TU curve rises upwards from left to right and later slopes downwards. The MU curve slopes downwards and goes to negative.

Conclusion :
The above explanation of this law clearly depicts that as the consumer goes on consuming the units of a commodity, the total utility increases and reaches saturation point and decreases. The marginal utility decreases and becomes zero and becomes negative.

Question 2.
Explain the features of indifference curves with the help of diagrams.
Answer:
1. A higher indifference curve represents a higher level of satisfaction than a lower indifference curve.
As the consumers income increase and the prices of the good permit him to buy more commodities, he moves to a higher indifference curve. In the diagram, the point R is preferable to the point S as it gives more satisfaction than point S.

2. The indifference curves are downward sloping from left to right.
The IC has a negative slope. The reason is, if the consumer has to stay at same level of satisfaction, the quantity of one commodity must decrease when the quantity of the other commodity increases.

3. Indifference curve cannot intersect each other.
Two 1C never intersects each other because they represent two different sets of combinations of two goods providing unequal level of satisfaction.

4. An indifference curve must always be convex to the origin and not concave.

If the IC is concave, the MRS will be increasing, which is unrealistic. As the stock of commodity falls, our preferences for the remaining units must increase. The MRS must always diminish. Then the IC will be convex to the origin.

Question 3.
Explain the derivation of demand curve in the case of a single commodity.
Answer:
The law of demand shows the relationship between the price of a good and the quantity de-manded for the same good. The law can be explained with help of statement and schedule and diagram.

Statement: The law of demand states that, “Other things remaining constant (Ceteris Paribus), when the price of a good decreases, the quantity demanded increases for the good, and when the price of a good increases, the quantity demanded decreases for the good.”

In the above statement, other things refers to the prices of related goods, the consumer’s income, tastes and preferences etc. when all these factors are constant, the demand for a good depends on price of a good. Therefore, according to the law of demand, the price and the quantity demanded move in opposite direction.

Individual Demand Schedule
The law of demand can be explained with an example. Suppose a consumer wants to purchase Apple in the market. The demand of an individual consumer depends on its price. As the price varies, the quantity demanded also varies. The individual’s demand for Apple is shown in the demand schedule.
The individual demand schedule

Price of Apple per kg (₹)	Demand for Apple(in Kgs)
4	12
5	10
6	8
7	6
8	4

The above demand schedule shows that, as the price varies the individual’s quantity demanded also varies. When the price of apple is ₹ 4 per kg, the quantity demanded is 12 kgs. If the price increases to ₹ 5 per kg, the quantity demanded is 10 kgs and finally when the price increases to ₹ 8 per kg, the quantity demanded decreases to 4 kgs.
As per the law of demand, as when the price increases on apple the quantity demanded decreases for apple and vice-versa.
With the help of individual demand schedule, an individual demand curve can be drawn to show how the quantity demanded varies as the increase/ decrease in the price of apple.

The individual demand curve :

With the help of demand schedule, the law of demand can be obtained with the help of a graph. The graphical presentation of the demand schedule helps us to draw the demand curve.
Individual Demand Curve

In the above diagram, on ‘OX’ axis we measure quantity demanded on ‘OY’ axis we measure price. ‘DD’ is the demand curve. Various points on the curve (e,f,g,h,i] show different price levels and respective quantities demanded.
At the point ‘e’ the price is ₹ 4 and quantity demanded is 12 kgs and point f shows that the price is ₹ 5 and quantity demanded is 10 kgs and so on.

Thus, as the price of a good decrease the quantity demanded increases, and as the price of a good increases, the quantity demanded decreases and hence the demand curve slopes downward from left to right which is shown in the above diagram.

Conclusion :

With the help of the demand schedule and demand curve it has been made clear that the demand and price are inversely related. And when the price of a good increase, the quantity demanded decreases and when the price of a good decreases the quantity demanded increases, helping other things remaining constant.

Question 4.
Explain the optimal choice of consumer with the help of a diagram.
Answer:
The indifference curve depicts the choice and priority of a consumer. The budget line shows the
ability to pay. Choice and priority can be achieved only when there is affordability. There¬fore, in order to achieve consumer’s equilibrium that maximizes utility, the indifference curves have to be combined with the budget line to determine the combination of goods that can be purchases within a certain amount of budget.

Assumptions: The following are the assumptions of consumer equilibrium under indifference curve analysis.

1. Income of the consumer is given
2. Consumer is rational and wants to maximize her/his satisfaction from her/his limited income.
3. Prices of goods and services are constant.
4. Consumer is aware of the indifference map.
5. All goods are homogeneous and divisible.
6. The condition of transitivity is satisfied. If combination A>B and B>C, then A>C.
7. The condition of non-satiety holds. The consumer prefers more of one commodity or of the other or of both equally.

The consumer’s equilibrium is shown in the diagram below.

In the diagram, there are four indifference curves – IC₁ , IC₂, IC₃ and IC₄ and a budget line PQ. Which of the points from A to D is an optimal, utility maximizing, optimum choice?
Point B is not optimal. A is better than B since A is on a higher indifference curve. The consumer has to choose A, since A is on the budget line.

Similarly point C is also not optimal, because both B and C are on the same indifference curve. Therefore, B is as good as C. However, A is better than B and consequently, A must be better than C.

Point D can also not be optimal. D is on a higher indifference curve than any of the other baskets, A to C. it, therefore produces the highest level of utility. However, the consum it lies outside the budget line. Therefore, D is not an optimal choice.

Point A can be optimal. A is the only combinations that gives the maximum utility. All other points that lie on or below the budget line give higher or lower levels of utility. At point A, the indifference curve just touches the budget line and equilibrium is achieved at that point. Point A has an interesting property. At that point m the budget line and the indifference curve have exactly the same slope. This can be expressed as
\(\frac{P_{x}}{P_{y}}=\frac{M U_{x}}{M U_{y}}\)

This rule states that the willingness to substitute \(\left(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{MU}_{\mathrm{y}}}\right)\) equivalent to the ability to pay \(\frac{P_{x}}{P_{y}}\)

Thus we can say that the consumer is in equilibrium position when the price line is tangent to the indifference curve or when the marginal rate of substitution of goods X and Y is equal to the price ratio between the prices of the two goods.

The indifference curve theory is an ordinal theory which explains the consumer’s preference between alternative bundles of goods by means of indifference curves. A single curve joins all those combinations of goods which give the consumer equal satisfaction of utility and between which the consumer is thus indifferent. The consumer reaches equilibrium for a given money income and gives market price when he reaches the highest attainable level of satisfaction. At such a point, the budget line is tangent to the indifference

Question 5.
Explain the movement along the demand curve and shift in demand curve with the help of two diagrams.
Answer:
Movement along the demand curve: We know that the amount of a good that the consumer chooses depends on the price of the good, the prices of related goods, income of the consumer and tastes and preferences. The demand function is the relation between the amount of the good and its price when other things remain constant. The demand curve is graphical repre¬sentation of the demand function. At higher prices, the demand is less, and at lower prices, the demand is more. Thus any change in the price leads to movements along the demand curve.

Shifts in the demand curve:
Meaning: Shift in the demand curve occurs because, except price, change in any of the other things leads to shift in the demand curve.
The shift in the demand curve can be explained clearly with the help of diagram and with the changes in the determinants of demand.

1. Let us see what happens to the demand curve if there is change in consumer’s income keeping no change in price, with the help of diagram,

In the above diagram, on OX axis we measure quantity demanded and on OY axis we measure price.

Other things remaining constant, if the income of a consumer increases, the demand for the good increases and hence there is shift in the demand curve to right and these goods are normal goods, because when income increases demand also increases. It is shown in the above diagram, that is, when income increases, keeping price as constant, the quantity demanded also increases from DD to D¹D¹ and Q to Q₁

And for the inferior goods, the demand curve shifts to left from DD to D²D² and Q to Q₂, because as the income increases, the demand for inferior good decreases. Hence the demand curve shifts to left.

Note: For Normal goods the demand curve shifts to right For Inferior goods the demand curve shifts to left.

2. Let us see what happens to the demand curve if there is change in price of related goods. If the price of a related good changes, the demand for the goods which the consumer wants to. buy, changes at each level of its price, and hence, there is a shift in the demand curve.
If there is an increase in the price of a substitute good, the demand curve shifts to the right. For example, if the price of coffee increases, consumer can shift to tea, and therefore demand for tea increases. Hence the demand curve of tea shifts to the right.

On the other hand, if there is an increase in the price of complementary good, the demand curve shifts to left.
For example, the demand for the petrol may increase if there is an increase in the price of bikes. Therefore, the demand curve of petrol shifts to left.

Note: For Substitutes demand curve shifts to right
For complementary goods demand curve shifts to left.

Conclusion: With the help of above examples we can conclude that Expect price, if other determinants of demand change the demand curve shifts to right and left.

Question 6.
Give the meaning and formula of price elasticity of demand and explain the elasticity along a linear demand curve.
Answer:
Price Elasticity of Demand: It is a measure of the responsiveness of the demand for a good to change in its price, that is, changes in the quantity demanded with respect to changes in the price.
eD = percentage change in demand for the good /percentage change in the price of the good
eD = ∆Q/Q x P/∆P
Elasticity along a Linear Demand Curve

Let us consider a linear demand curve q=a – bp. Note that at any point on the demand curve, the change in demand per unit change in the price ∆q/∆p = – b.
It is clear that the elasticity of demand is different at different points on a linear demand curve, which is shown in the diagram.
In the above diagram, at p=0, the elasticity is 0, at q = 0, elasticity is oo. At p = a/2b, the elasticity is 1, at any price greater than 0 and less than a/2b, elasticity is less than 1 and at any price greater than a/2b, elasticity is greater than 1.

Question 7.
Explain the derivation of the demand curve from indifference curve and budget
constraints.
Answer:
Consider an individual consuming bananas (X₁)and mangoes (X₂), whose income is M and market prices of X₁ and X₂ are P’₁ and P’₂ respectively. Figure (a) depicts her consumption equilibrium at point C, where she buys X’₁ and X’₂ quantities of bananas and mangoes respectively. In panel (b) of figure 2.14. we plot P’₁ against X’₁ which is the first point on the demand curve of X₁.

Suppose the price of X₁ drops to P₁ . with P’₂ and M remaining constant. The budget set in pane! (a), expands and new consumption equilibrium is on a higher indifference curve at point D, where she buys more of bananas (X₁ > X’₁ ). Thus, demand for bananas increases as its price drops. We plot X₁ against X₁ in panel (b) of figure 2,14 to get the second point on the demand curve for X₁ . Likewise the price of bananas can be dropped further to P₁ , resulting in further increase in consumption of bananas to X₁ .P₁ plotted against X₁ > gives us the third point on the demand curve. Therefore, we observe that a drop in price of bananas results in an increase in quality of bananas purchased by an individual who maximises his utility, The demand curve for bananas is thus negatively sloped.