Opportunity Cost

1) What is opportunity cost?

A) The opportunity cost of a good is the value of the next best alternative good forgone for it.
Ex;-Suppose a given value of resources can be used to produce either a car or 60 computers.
Then, the true value of a car is not its MP but 60 computers which are forgone to produce a car.
2) What is marginal opportunity cost?
A) Marginal opportunity cost of a good is the amount of the other good satisfied for the
production of an additional unit of the former good, resources and technology remaining the
same.
3) Why is production possibility curve concave to the origin?
A) It is the increase in the marginal opportunity cost that makes the production possibility curve
concave to the origin.

Consumer Behavior and Demand

1) Distinguish between total and marginal utility?
A) Total utility is the total amount of satisfaction which a consumer obtains from consuming a
certain number of units of a good consumed. On the other hand, marginal utility is the addition
made to total utility by consuming an extra unit of a good.
Suppose a person obtain 12 units of satisfaction from the first unit of a good, say an
orange, 10 units of extra satisfaction from the second unit and 8 units of satisfaction from the
third unit of good. The total utility of the three units consumed by him is equal to 12+10+8=30
units, whereas the marginal utility of the first unit of the good is 12, of the second unit is 10 and
third unit is 8.
Thus, the total utility obtained by a consumer can be obtained by summing up the
marginal utilities of the three units consumed by him.
Hence, TU = Sum of MU
2) What is consumers equilibrium?
A) A consumer is in equilibrium when he is spending his given income on various goods in such
a way that he maximizes his satisfaction.
3) State the condition of consumers equilibrium.
A) For a consumer to be in equilibrium he must distribute his given income among various goods
in such a way that marginal utility derived from the last rupee spent on each good is the same.
Thus, in case of two goods X and Y a consumer is in equilibrium when:
MUx = MUy = MUm
Px
Py
4) State the law of diminishing marginal utility.
A) As a consumer consumes more units of a commodity marginal utility obtained from an
additional good of it goes on diminishing.

Consumer Behavior And Demand

Demand
1) Give the meaning of Demand.
A) Demand refers to the desire to buy a commodity backed by willingness and ability to
purchase that commodity.
2) What is a demand schedule?
A) Demand schedule is the tabular presentation of the different amount of a commodity
demanded at different possible price of that commodity.

3) What is individual demand schedule?

A) Individual demand schedule states the relationship between price and quantity demanded of a
commodity by an individual.
4) What is market demand schedule?
A) Market demand schedule is the sum of the individual demand schedule for a commodity in
the market.
5) What is demand curve?
A) It is a graphic presentation of the reverse relationship between price and quantity demanded
of a commodity.
6) What is law of demand?
A) Law of demand states that, other things being constant, more of a commodity is purchased in
response to its decrease price.
7) Differentiate between substitute and the complementary goods?
A) Substitute goods are those goods which can be used in place of each other. If the price of the
commodity increases then the demand for its substitute also increases as it become relative
cheaper. Similarly, if the price of a commodity decreases the demand of its substitute decreases.
For e.g.:- Tea and Coffee, Ball- pen and Ink pen.
Complementary goods are the goods which are used together to satisfy a given want. If the
price of one good increase then the demand for its complementary decreases and vice versa. For
e.g.:- Car & Petrol, Fountain Pen & Ink.
8) Explain the law of demand with he help of a diagram. Give its exceptions &
importance.
A) The law of demand states that other things being equal, the amount demanded of a
commodity decreases with rise in the price and increases with fall in the price. So, there is a
inverse relationship between price and quantity demanded.
This is explain with the help of a diagram below. Both demand schedule and demand curve are
showing an inverse relation ship between price and quantity demanded.
Demand schedule & Demand Curve showing inverse relationship between price & Q.Demand.
Demand Schedule
Price Per Unit
Quantity Demanded
10
50
8
60
6
70
4
80
2
90

Demand Curve
y
D
P
r
i
c
e

D
X

O
Q. demanded
Exceptions to the law:The law will not hold good under following circumstances:(a) Goods of conspicuous consumption:- In such cases, higher price means more
consumption.
(b) Giifen goods:- When price of a Giifen good falls its demand also fall.
(c) Consumers ignorance:- The law of demand break down when consumer judge quality of
a commodity by its price.
Importance:(a) The law of demand expresses general human behavior in the market place.
(b) It is based on this law that the producer plans their price policy with a view to
maximizing their profits or maximizing their sales.

9) Why does demand curve slope downwards? Explain?

A) The demand curve of normal goods slopes downward because of the following reasons:
i) Law of diminishing marginal utility:- According to the laws, the utility derived from
each successive unit of a commodity tends to diminish. Since Px = MUx diminishing MUx must
mean diminishing Px corresponding to greater purchase of the commodity.
ii) Income effect:- A fall in price of a commodity causes increase in real income of the
consumers. Accordingly, quantity demanded of the commodity increases.
iii) Substitute effect:- when price of a commodity decreases in relation to the price of its
substitutes its quantity demanded increases in place of the substitute good.
iv) Size of consumer Group:- When the price of a commodity falls, many consumers who
were not buying it at its previous price begin to purchase it now.
10) What do you understand by assumptions of law of demand?
A) The main assumptions of law of demand are:1) No change in income.
2) No change in taste and preference of the consumer.
3) Price of the related commodity should remain constant.
4) No change in the size of population.
5) No change in distribution of income and wealth.
6) Perfect competition.
11) Differentiate between extension and contraction of demand?
A) The extension of demand occurs due to the reduction in price whereas contraction in demand
follows an increase in price.
For instance, the demand for commodity X is 10 kg at a given price of Rs. 10. Now, suppose the
price of the very commodity falls to Rs. 5 and demand will increase to 12 kg. This is called
extension in demand. On the other hand, if the price of the commodity increases to Rs.12,
demand will decrease. such a situation will refer to the contraction of demand.

Case I

Extension & Contraction of Demand

Price Rs.
Quantity

Description

1
5

Fall in price
Rise in Demand

5
1

Rise in Price
Fall in Demand

5
1
1
5

Case II

D
P1

Extension

P2

Contraction

P1

P2
D
Q1

Q2

D
Q2

Q1

12) Differentiate between increase and decrease in demand?

A) Increase in demand refers to the situation when there is more demand at the same price or the
same demand at higher price. In such case, there will be a shift in demand curve in the upward
direction.
D
Increase in
Price
Demand
Demand
10
10
20
Case I
10
30
10
20
D
Case II
20
30
20

30

Decrease in demand means that either less quantity is demanded at the same price or same
quantity at lower price.
D

Case I
Case II

Price

Demand

10
10
10
05

20
10
20
20

Decrease in
Demand

Q1

13) Distinguish between movement along the demand curve and shift in the
demand curve?
A) Movement along the demand:- Due to change in price of a good, other factors influencing
demand remaining the same, a consumer moves along a given demand curve. As a result of rise
in price of a commodity the quantity demanded of the commodity falls and he therefore moves
up on the demand curve. On the other hand when price of the commodity falls, other factors
remaining the same, he buys more of the commodity and therefore moves down on the demand
curve.

Shift in Demand Curve: - When factors other than price changes, the entire demand curve
shifts. If a consumers income increases or he start preferring the commodity more the demand
increases and as a result demand curve shifts towards the right. On the other hand when a
consumers income decline or price of its substitute good falls, the consumers demand for the
commodity decreases and its demand curve shifts to the left.
Thus, whereas movement along the demand curve takes place due to the changes in price
of the commodity alone, shift in the demand curve occurs due to the factor other than price.

Price Elasticity Of Demand

1) Define price elasticity of demand.
A) Price elasticity of demand measures the degree of responsiveness of quantity demanded of a
good to changes in its price, given the consumers income, his preference and prices of other
goods. Precisely, price elasticity as defined as the ratio of proportionate change in price.
Price Elasticity = Percentage change in Quantity Demanded
Percentage change in Price
2) Explain the meaning of elastic demand and inelastic demand as understood in
economics.
A) Elastic Demand: - When price elasticity of a commodity is greater than one, demand for that
commodity is said to be elastic. In case of demand percentage, increase in quantity demanded is

greater than the percentage fall in the price so that the total expenditure on the commodity
increases when the price falls and vice versa.
Inelastic Demand:- When coefficient of price elasticity for a commodity s lee than one, demand
percentage increases in quantity demanded is less than the percentage fall in price so the total
expenditure on the commodity decreases when the price falls and vice versa.
Thus, Demand is elastic if ep > 1
Demand is inelastic if ep < 1
3) Explain any three factors on which price elasticity of demand depends.
A) The price elasticity of demand is determined by the following factors:i) Availability of substitutes:- If for a commodity close substitutes are available, its
demand tends to be elastic. If the price of the commodity goes up, the people will shift to the
close substitute and as a result the demand for that commodity will greatly decline. The greater
the possibility of substitution, the greater the price elasticity of demand for it. If for a commodity
substitutes are not available, people will have to buy it even when its price rises, and therefore its
demand would tend to be inelastic.
ii) The number of uses of a commodity:- the greater the number of uses of a commodity
the higher will be its price elasticity.
iii) The nature of a commodity:- As whether it is a necessity or a luxury good. Demand
for necessities is inelastic while for luxury is elastic.
iv) Time Period:- The duration of time also influence the elasticity of demand for a
commodity. Demand tends to become elastic if time involved is long. This is because consumer
can substitute goods in the long run. In the short run, substitution of the commodity by another is
not so easy.

Price

4) Explain degree or types of price elasticity.

A) Perfect Elastic Demand:- Perfectly elastic demand is said to be happen when a little change
in price leads to an infinite change in quantity demanded. A small rise in price on the part of the
seller reduces the demand to zero. In such a case the shape of the demand curve will be
horizontal straight line.
Y

X
Perfectly Inelastic demand:- Perfectly inelastic demand is opposite to perfectly elastic demand.
Under perfectly elastic demand, irrespective of any rise or fall in price of a commodity, the
quantity demanded remains the same. The elasticity of demand in this case will be equal to zero.

Unitary Elastic Demand:- the demand is said to be unitary elastic when a given proportionate
change in price level brings about an equal proportionate change in quantity demanded. The
numerical value of unitary elastic demand is exactly one i.e. Ed = 1. Marshall call it unit elastic.

Relatively elastic Demand:- relatively elastic demand refers to a situation in which a small
change in price leads to a big change in quantity demanded. In such a case elasticity of demand
is said to be more than one.

Relatively Inelastic Demand:- Under this relatively inelastic demand a given percentage change
in price produces a relative less percentage change in quantity demanded. In such a case
elasticity of demand is said to be less than 1.

5) What are the factors determining Elasticity of demand.

A) Factors determining elasticity of demand are:i) Necessaries of Life:- For necessaries of life the demand is elastic or inelastic because
people buy required amount of goods whatever their price is. E.g. Rice, salt etc.........
ii) Conventional Necessaries:- The demand for conventional necessaries is less elastic or
inelastic. People who are accustomed to the use of goods like intoxicants which they purchase at
any price. E.g. Wine, cigarette etc..
iii) Substitutes:- demand is elastic for those goods having substitutes and inelastic for
those good which have no substitutes. E.g. Tea and Coffee..
iv) Number of uses:- Elasticity of Demand for any commodity depends on its number of
uses. Demand is elastic if the commodity has more uses and inelastic if it has only one use. E.g.
Coal has elastic demand.
v) Raw material and finished goods:- The demand for raw material is inelastic but the
demand for finished goods is elastic. E.g. Petrol has inelastic demand while Car has elastic
demand.
vi) Habits: - If consumers are habituated of some commodities the demand for such
commodities will be inelastic. This is because the Consumer consumes them even at high prices.
E.g. A smoker does not smoke less when the price of the cigarette will goes up.
6) What are the Importance of elasticity of Demand?
A) 1) Useful for Business:- It enables the business in general and the monopolistic in particular
to fix the price. Studying the nature of demand the monopolist fixes higher price for those goods
which have inelastic demand and lower prices for goods which have elastic demand. On this
way, they maximize profit.
2) Fixation of Prices:- It is very useful to fix the price of jointly supplied goods. In the case of
joint product like paddy and shaw, the cost of production is not known. The price of each is then
fixed by its elastic and inelastic demand.
3) Wage Bargaining:- The same argument applies to the price of labour i.e. the wage rate. Trade
union demand high wage rates if the elasticity of demand for labors are low.
4) Indirect Taxation:- The concept of elasticity is also important for the government, when it tries
to fix the rate of indirect taxes because these taxes affect the price of the commodities. The
government has to levy taxes on goods which have inelastic demand to get a high tax revenue
without changing the demand.
5) International Prices:- When two countries engage in trade, the term of trade are determined by
the reciprocal elastic ties of demand of the two countries for each others goods.
6) Devaluation policy:- Sometimes when a country suffers from an adverse balance of Payment
i.e. the value of imports exceed the value of exports, the government devalues the currency. The

government reduces the price of domestic currency in terms of foreign currency. This helps in
solving the balance of payments problem by increasing the price of imported goods in the
domestic market and hence reducing the demand for imports.