NMIMS Global Access

School for Continuing Education (NGA-SCE)

Course: Business Economics
Internal Assignment Applicable for December 2021 Examination

1.What is Indifference Curve, explain with the help of diagram and also explain its
properties.

Ans - An indifference curve is a graph showing combination of two goods that give the
consumer equal satisfaction and utility. Each point on an indifference curve indicates that a
consumer is indifferent between the two and all points give him the same utility.

Property I. Indifference curves slope downward to the right:

This property implies that an indifference curve has a negative slope.
This property follows from assumption I. Indifference curve being downward sloping means
that when the amount of one good in the combination is increased, the amount of the other
good is reduced. This must be so if the level of satisfaction is to remain the same on an
indifference curve. For instance, the amount of good X is increased in the combination, while
the amount of good Y remains unchanged, the new combination will be preferable to the
original one and the two combinations will not therefore lie on the same indifference curve
provided more of a commodity gives more satisfaction.

Property II: Indifference curves are convex to the origin:

Another important property of indifference curves is that they are usually convex to the
origin. In other words, the indifference curve is relatively flatter in its right-hand portion and
relatively steeper in its left-hand portion. This property of indifference curves follows from
assumption 3, which is that the marginal rate of substitution of X for Y (MRSxy) diminishes
as more and more of X is substituted for Y.
Only a convex indifference curve can mean a diminishing marginal rate of substitution of X
for K If indifference curve was concave to the origin it would imply that the marginal rate of
substitution of X for y increased as more and more of X was substituted, for Y. When the
indifference curve is convex to the origin, MRS diminishes as more of X is substituted for K.
We therefore conclude that indifference curves are generally convex to the origin. Our
assumption regarding diminishing MRSxy and the convexity of indifference curves is based
upon the observation of actual behaviour of the normal consumer. If indifference curves were
concave or straight lines, the consumer would succumb to monomania, that is, he would buy
and consume only one good. We know that consumers in actual world do not generally buy
and consume one good. It is for this reason that we reject indifference curves of concave or
straight-line shapes and assume that indifference curves are normally convex to the origin.

The degree of convexity of an indifference curve depends on the rate of fall in the marginal
rate of substitution of X for Y. As stated above, when two goods are perfect substitutes of
each other, the indifference curve is a straight line on which marginal rate of substitution
remains constant. The better substitutes the two goods are for each other, the closer the
indifference curve approaches to the straight line so that when the two goods are perfect
substitutes the indifference curve is a straight line.

Property III: Indifference curves cannot intersect each other:

Third important property of indifference curves is that they cannot intersect each other In
other words only one indifference curve will pass through a point in the indifference map 1
his property can be easily proved by first making the two indifference curves cut each other
and then showing the absurdity or self-contradictory result it leads to.

In Fig. 8.5 two indifference curves are shown cutting each other at point C. Now take point
on indifference curve IC2 and point B on indifference curve IC1 vertically below A. Since an
indifference curve represents those combinations of two commodities which give equal
satisfaction to the consumer the combinations represented by points A and C will give equal
satisfaction to the consumer because both lie on the same indifference curve IC2. Likewise,
the combinations B and C will give equal satisfaction to the consumer; both being on the
same indifference curve IC1. If combination A is equal to combination C in terms of
satisfaction, and combination B is equal to combination C, it follows that the combination A
will be equivalent to B in terms of satisfaction. But a glance at Fig.8.5 will show that this is
absurd conclusion since combination A contains more of good Y than combination B, while
the amount of good X is the same in both the combinations.

Thus, the consumer will definitely prefer A to B, that is, A will give more satisfaction to the
consumer than B. But the two indifference curves cutting each other lead us to an absurd
conclusion of A being equal to Bin terms of satisfaction. We therefore conclude that
indifference curves cannot cut each other.

Another point which is worth mentioning in this regard is that indifference curves cannot
even meet or touch each other or be tangent to each other at a point. The meeting of two
indifference curves at a point will also lead us to an absurd conclusion. The same argument
holds good in this case as developed above in the case of intersection of indifference curves.

Property IV: A higher indifference curve represents a higher level of satisfaction than a lower
indifference curve:
The last property of indifference curve is that a higher indifference curve will represent a
higher level of satisfaction than a lower indifference curve. In other words, the combinations
which lie on a higher indifference curve will be preferred to the combinations which lie on a
lower indifference curve. Consider indifference curves IC1 and IC2 in Fig. 8.6. IC2 is a
higher indifference curve than IC1. Combination Q has been taken on a higher indifference
curve IC2 and combination S on a lower indifference curve IC1.Combination Q on the higher
indifference curve IC2 will give a consumer more satisfaction than combination S on the
lower indifference curves IC1 because the combination Q contains more of both goods X and
Y than the combination S. Hence the consumer must prefer Q to S. And by transitivity
assumption, he will prefer any other combination such as combination R on IC2 (all of which
are indifferent with Q) to any combination on IC1 (all of which are indifferent with S) We,
therefore, conclude that a higher indifference curve represents a higher level of satisfaction
and combinations on it will be preferred to the combinations on a lower indifference curve.

2. Consider the demand for a good. At price Rs 4, the demand for the good is 25 units.
Suppose price of the good increases to Rs 5, and as a result, the demand for the good
falls to 20 units. Calculate the price elasticity?
Ans- Price elasticity of demand (Ed)=(−)QP×△P△Q
Here, P = Rs.4; P1= Rs.5;
△P = P1−P = Rs.5 − Rs.4 = Rs.1
 Q = 25 units ; Q1 = 20 units ;
△Q = Q1 − Q = (20−25) units = (−)5 units
Ed = (−) 4/25 × -5/1
=0.8.

3.a. Two goods have a cross-price elasticity of demand of +1.2 (a) would you describe the
goods as substitutes or complements? (b) If the price of one of the goods rises by 5 per
cent, what will happen to the demand for the other good, holding other factors constant?
Ans- (A)Any goods with positive price elasticity are considered as substitute goods. As in
this case the price elasticity of the demand is +1.2, we can consider this as substitute one's

(b) In case of any one of the substitute's price is increased or rises by 5%, it will be
substituted by other good the quantity demand of this other good will rise.
The rise or increase in the quantity demand of this other good = 1.2* 5= 6%

3.b. Calculate Marginal Utility and Average Utility from the information given in the below
table:

Quantity Consumed Total Utility

1 20
2 35
3 47
4 55
5 60

Ans - Quantity Consumed x Total Utility = Marginal Utility

Quantity Total Utility Marginal

Consumed Utility
1 20 1x 20 = 20
2 35 2 x 35 = 70
3 47 3 x 47 = 141
4 55 4 x 55 = 220
5 60 5 x 60 = 300
 Total - 751

Average Utility = Total Marginal Utility/Total Quantity Consumed

(751 ÷ 15 = 50.06)
Average Utility = 50.06