Quiz for CP

1. Egg Industry: Majority of the poultry farms in India were non-

mechanized till the recent past. In 2012, with the invention of new
technology we observed an increase in the process of egg production. On
the other hand, the society has become more health conscious and their
consumption of eggs have gone down. Assuming eggs to be normal
product, what would happen to the equilibrium price and quantity of eggs
produced. Explain the causes.
 2. Education Industry: After implementation of AICTE regulations, the
higher educational institutes in India implemented the norms for
maintaining good standard of education. This means capital expenditure
on the classrooms, laboratories and libraries. With implementation of 7th
Pay Commission, the salaries of faculty also needed to be increased. At the
same time, due to increased awareness about education, more students
enrolled in colleges. Assuming college education as an inelastic good,
determine what would happen to the equilibrium prices and quatity of
college education.
 3. Rice is traded in a competitive world market, and the world price is Rs. 900 per
kg. Unlimited quantities are available for import into India at this price. Indias
domestic demand and supply for various price level are shown as follows:

What is the equation for demand? What is the equation for supply?
At a price of Rs. 900, what is the price elasticity of demand? What is the price
elasticity at a price of Rs. 1200?
What is the price elasticity of supply at Rs. 900 and Rs. 1200?
In a free market, what will be the Indian price and level of rice imports?
Price (Rs.) Indias Supply (thousand kgs) Indias Demand (thousand
kgs)
300 2 34
600 4 28
900 6 22
1200 8 16
1500 10 10
1800 12 4
Consumer Behavior
Consumer Behavior

How a consumer with limited income decide which goods and

services to buy?

Consumer preferences: The reasons people might prefer one good to

another.

Budget constraints

Consumer choices: Consumers choose to buy combinations of goods that

maximize their satisfaction. Combination depends on prices of goods.
Assumptions about preferences
Completeness:
Consumer can compare and rank all possible baskets.
A consumer can prefer A to B or vice-versa. He may indifferent too.
Preferences are irrespective of cost.

Transitivity: Preferences are transitive.

Transitivity is necessary for consumer consistency.

More is better than less: Consumers always prefer more of any

good to less.
Indifference Curves
Indifference curve represents all combinations of market baskets that provide a
consumer with same level of satisfaction.
Market Basket Units of food Units of

Clothing (units per week)

clothing
50
A 20 30 B
B 10 50 40
F D
C 40 20
30
D 30 40 A
E 10 20
20 Ui
E C
F 10 40 10
0
A is preferred to E. D is preferred to A. 10 20 30 40 Food (units
Whether A is preferred to B and C? per week)
Indifference Curves
Indifference curves are always downward sloping.
What will happen if indifference curve is upward sloping?
50
B
One would always prefer D as
40
compared to A or E. So, there is no F D
indifference. 30
A
20
E C
Assumption of more is preferred to less is 10
violated. 0
10 20 30 40 Food (units
per week)
Indifference Curve

Indifference curves cannot intersect.

WHY?
A and B are on the same

Clothing (units per week)

indifference curve and so are A 50
and C.
By the property of transitivity, one 40
must be indifferent between B and
C. 30 B
U2
A
But, B have more of both goods, so 20 U1
the assumption of more is preferred C
to less is violated. 10
0
10 20 30 40 Food (units
per week)
Marginal rate of substitution
The downward sloping indifference curve
shows that consumer is willing to substitute
one good for obtaining more of other.
16 A
Marginal rate of substitution: Amount of good 14
that a consumer is willing to give up in order 12 -6
to obtain one additional unit of another good.

Clothing (units per

10 B
1

MRS = -C/F 8
-4
6 1
D
-2
E

week)
4 1
2
-1 G
1

0
1 2 3 4 5 6

Food (units per week)

Property of MRS
Convexity: due to 4th assumption of consumer preferences
Diminishing marginal rate of substitution: Indifference curves are convex.

As more of one good is consumed, the consumer would be willing to

give up fewer and fewer units of a second good to get additional unit
of first good.

The second differential of convex curve is positive i.e. as one moves down the
curve, MRS decreases at a lower rate.
 Perfect substitutes and perfect
complements
Perfect Substitutes: When MRS of Perfect Complements: When MRS of one
one for the other is a constant. for the other is zero or infinite.

8
16
7
14
6
12
Apple juice (glasses)

5
10
4
8

Left shoe
3
6
2
4
1
2
0
0 1 2 3 4 5 6
1 2 3 4 5 6

Orange juice (glasses) Right shoe

Utility
Utility: Numerical score representing satisfaction that a
consumer gets from a market basket.
Utility function: Formula that assigns a level of utility to
individual market baskets.
U(F,C) = F+2C
Calculate the utility of a market basket having 10 units of food and 4 units of
clothing.
Find another market basket of food and clothing having the same utility.
A utility function can be represented by a set of indifference
curves, with a numerical indicator.
Ordinal and cardinal utility

Ordinal utility: Utility function that generates a ranking of

market baskets in order of most to least preferred.
But by how much one basket is preferred to other?

Cardinal utility: Utility function that describes by how much one

market basket is preferred to another.
Budget Constraint
Budget constraint: Constraints that consumers face as a result of
limited resources.
It limits consumers choices.

Budget line: All combinations of goods for which the total amount
spent is equal to income.

Let us have two goods: Food (F) and Clothing (C)

PF F+PC C=I
Total income = Rs. 8000 PF = Rs. 100 per unit PC = Rs. 200 per unit
Write 100F+200C=8000
on board
Market Food (F) Clothing (C) Total Spending Clothing (units
per month)
Basket units units (Rs)
A 0 40 8000
B 20 30 8000 I= PC
40 A
C 40 20 8000 B Slope C/F= -1/2= -PF/PC
30
D 60 10 8000 C
20
E 80 0 8000 D
10
E
0
20 40 60 80 I= PF
Food (units per month)

Slope = Ratio of price of food to clothing= Marginal rate of substitution

Price ratio is always inverse of quantity substituted.
 Effect of change in income and price
Change in income: Alters the vertical Can you find similarity with shift
intercept. Shift in budget line. of demand curve
Clothing (units
PF F+PC C=I can be solved as C= (I/PC )-(PF/ PC) F. 80 per month)

Clothing (units
per month)
Change in price: I= PC
Change in slope of 40 A
B I=16000
I= PC budget line. 30
I=8000
40 C
PC = Rs. 200 per unit 20
D
30
PF1= Rs. 100 per unit 10
E
20 PF2= Rs. 50 per unit 0
20 40 60 80 I= PF 160
10 -PF3/PC= -PF1/PC=
-1 -1/2
-PF2/PC=
-1/4
PF3= Rs. 200 per unit Food (units per month)
0
20 40 60 80 I= PF 160
Food (units per month)
Consumer choice
Consumers maximize market basket based on:
The market basket must lie on budget line.
It must give the consumer most preferred combination of goods and
services.
Clothing (units
per month) At which point the utility is
maximized?

I= PC
Utility is maximized at point C
40 Slope C/F= -1/2=
B D -PF/PC = MRS Maximization is where the
30
C
budget line is tangent to
20 U3 indifference curve.
10
U2
0
U1
20 40 60 80 I= PF
Food (units per month)
Consumer choice
Satisfaction is maximized when marginal benefit is Optimization problem of
equal to marginal cost. economics

Clothing (units
per month)

At point B, the price ratio PF/PC= -1/2,

but MRS=1.
I= PC
40 Slope C/F= -1/2= So utility is not maximized.
B D -PF/PC = MRS
30 The budget line is not true representative
C
20 U3 of income constraint.
10 U2
U1
Discuss corner solution on board
0
20 40 60 80 I= PF
Food (units per month)
Revealed Preferences
If a consumer chooses one market basket over another, and if the
chosen market basket is more expensive than the alternative, then
the consumer must prefer the chosen market basket.

Clothing (units
per month) A is preferred to B and B is
preferred to C, so A must be
preferred to C.
A Assumptions of transitivity and
consistency
B
C
BL 1 BL 2

Food (units per month)

Marginal Utility
Marginal utility measures the additional satisfaction obtained from
consuming one additional unit of a good.

Diminishing marginal utility is the principle that as more of a good is

consumed, the consumption of additional amounts will yield smaller
additions to utility.
In the e.g. of food and clothing, utility derived from consumption of
one additional unit of food is equal to utility reduced by lesser
consumption of cloth
MUF (F)= -MUC (C); -(C/ F)= MUF/MUC
MRS=MUF/MUC ; PF/PC=MUF/MUC ; MUF/ PF=MUC/PC
Cost of living Indexes
CPI: Measure of the cost of a typical consumers entire market
basket.
Cost of living index: Ratio of the present cost of a typical bundle
of consumer goods and services compared with the cost during
a base period.