43707219 9295316 economics indifference curve

8/8/2019 43707219 9295316 Economics Indifference Curve

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SCALE OF PREFERENCE :-The concept of scale of preference is the base of indifference curve

analysis. Now, we see what is meant by Scale of preference.Suppose, a consumer is in a position to arrange the different

combination of two goods say X & Y, in order to buy or consume it, then hehave to arrange the combination in ascending or descending order ofpreference. He could tell us that the satisfaction derived from the firstcombination is more than, equal to or less than from the secondcombination but not the exact difference (in number) in satisfaction derivedfrom any two combinations.

Thus, every consumer arranges these combinations in order ofpreference.

This conceptual arrangement of combination of goods set in orderof level of preference or importance is called the scale of preference.

I ND I FFERENCE CURVE:- A n Indifference curve is the locus of all those combination of any two goodswhich give the same level of satisfaction to the consumer. (i.e.) He will beindifference between that combination and he does not matter if any combinationhe gets.

Indifference S chedule :-Combinations Goods (X) Goods (Y) Level of satisfactions

A 1 18 SB 2 13 SC 3 9 SD 4 6 Se 5 4 S

S = Same leve l of Satis f acti on.

In the above schedule there are 5 combinations of 2 goods (X) and (Y)But all are achieved combinations of (X)and (Y).

The consumer is indifferent between them. It can be explained infurther detail as _

To get one more units of X the consumer prefer to give up 5 units orY. The gain in utility of one additional unit of X will exactly compensatedthe consumer by the loss of 5 units of Y. Thus the total level of satisfactionfrom (1X + 18Y) is equal to (2X + 13Y).

Similarly, the total utility or the level of satisfaction from (2X + 13Y)is equal to (3X + 9Y) and so on. Since all these combinations gives the samelevel of satisfaction they are also known as Iso-utility combination.

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Indifference schedule in Indifference curve as shown below: y

20 A 15 B10 C05 D0 E IC1

1 2 3 4 5 x

In the above figure, X-axis represents product X and Y axisrepresents product Y. IC1 is the Indifference curve. Allcombinations of the goods X & Y represented by points A,B,C,D & Eon the Indifferent curve will be equally preferable to the consumer.

As these goods gives him the same level of satisfactions.

I ND I FFERENCE MAP : An indifference map is consists of a set of indifference curve drawntogether. It shows the scale of preference of consumer for differentcombinations of any two goods.

y

2015 IC31005 IC20 IC1

1 2 3 4 5 x

In the indifferent Map given above, all the combination of

two goods represented by the curve IC1 will give the consumer thesame level of satisfaction. But the level of satisfaction will be lessthan those given by IC2 and IC3 etc.

Higher and higher indifference curve represents higher &higher level of satisfaction as compared to lower one.

Therefore Indifference curve in a indifference map arelabeled in an ascending order such as IC0, IC1, IC2, IC3, IC10,IC100 ICn. Without actual measurement of utility.


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ASSUMPT I ON OF I ND I FFERENCE CURVE ANALYS I S . 1 . A consumer is assumed to buy any two goods in combinations . 2 . A consumer can rank the alternative combinations and compare

their level of satisfaction, and he prefers a combination providinga higher level of satisfaction .

3 . It is assumed that utility can be measured in ordinal numbers butnot in cardinal measurements .

4 . Consumer is rational and his choices are transitive . 5 . T he consumer behaviour is assumed to be constant, throughout

the analysis . 6 . Indifference curve analysis assumes diminishing marginal rate of

substitution.

P roperties of Indifference C urve The indifference curves possess certain characteristics which arealso called as properties. The important properties are:

1. Indifference curve must slopes downwards from left to right.2. Indifference curve must be convex to the origin.3. No two Indifference curves should intersect.

Let us see in detail one by one.Indifference curve m ust slopes downwards fro m left to right

y A y1

B y2 IC1

0 x1 x2 x

Indifference curves slopes downwards from left to right indicatingthat as the quantity of commodity X increases, the amount of commodity

Y should fall in order that the level of satisfaction from every combination should remain the same.

In the above figure, where the Indifference curve (IC1) slopesdownwards from left to right, shows that as the consumer moves frompoint A to B on (IC1), consuming more of commodity X [(i.e.) from o-x1 to o-x2 ] and less of commodity Y [(i.e.) from o-y1 to o-y2 ], level of satisfaction remains the same.


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Let us see weather, the indifference curve can slope upwards fro m left to right or that it is horizontal or vertical as shown in the following figure.

U pward sloping IC1

Y

y2 B

y1 A

0 x1 x2

In the upward sloping Indifference curve_ When the consumer prefers (0 x1) quantity of commodity X he prefers(0 y1) quandity of commodity Y at the point A. When the consumertends to prefer (0 x2) quandity of commodity X he prefers (0 y2)quandity of commodity Y at the point B.

From the diagram it is very clear that,

(0 x1) (0 x2) &

(0 y1) (0 y2)

Therefore, the satisfaction derived from the combination of goods X and Y at point B is greater than the satisfaction derived from the combinationof goods X and Y at point A.

This is happening, because the consumer moves from A to B on IC1consuming more of commodity X [ (i.e.) 0 x1 to 0 x2 ] and more of commodity Y [ (i.e.) from 0 y1 to 0 y2 ]

H

orizontal

y

A B IC1

x1 x2 x


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In the horizontal slopping of Indifference curve_ When the consumer prefers (0 x1) quandity of commodity X as well as(0 x2) quandity of commodity X he prefers the same quandity of Y (i.e.)(0 y1).

From the diagram, it is very clear that,

(0 x1) ( 0 x2) &

(0 y1) = (0 y1)

Therefore, the satisfaction derived from the combination of goodsX and Y at point B is greater than the satisfaction derived from the

combination of goods X and Y at point A.This is because the consumer moves from A and B on (IC1)Consuming more of commodity X (i.e. 0 x1 to 0 x2) and same level of commodity Y (i.e.) from 0 y1 to 0 y1.

V ertical IC1 y

y2

y1

x1 x

In the vertical sloping Indifference curve_ When the consumer prefers (0 y1) quandity of commodity

Y as well as (0 y2) quandity of commodity Y he prefers the samequandity of commodity X (i.e.) (0 x1)

From the diagram, it is very clear that,(0 x1) = (0 x1) &

(0 y1) (0 y2)

Therefore, the satisfaction derived from the combination of goods X and Y at point B is greater than the satisfaction derivedfrom the combination of goods X and Y at point A.

This is because the consumer move from A to B on (IC1)Consuming same level of commodity X {(i.e.) from 0 x1 to 0 x1}and more of commodity Y {(i.e.) from 0 y1 to 0 y2}.


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Indifference curve m ust b e convex to the originThe convexity of an Indifference curve is explained by the law

of diminishing marginal rate of substitution.Marginal rate of substitution between X and Y is the quantity

of good Y which the consumer is willing to give up for every additional unity of X, so that the level of satisfaction remains thesame, from all the successive combinations.

Combinations Goods (X) Goods (Y) MRSxy Level of satisfactions

A 1 18 SB 2 13 5:1 SC 3 9 4:1 SD 4 6 3:1 Se 5 4 2:1 S

Y A y 1 y2 B y3 C

D IC1 y4

x1 x2 x3 x4 X

Convexity implies that the consumer is willing to give up lessof good Y to obtain a little more of good X. This means, adiminishing slope ( y/ x ) of the indifference curve.

A rational consumer gives less significance to an extra unit of a commodity with a large stock and more significance to an unit of a commodity with a smaller stock. As the consumer moves downthe indifference curve, quantity or X becomes larger and that of Y

becomes smaller. In order to be at the same level of satisfaction,the consumer will sacrifice less and less of Y in exchange of X. SoMRS of X for Y will diminish as the consumer gets more and moreof X. Only then the subsequent combinations will give theconsumer an equal level of satisfaction. Hence indifference curvesare convex to the origin.


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N o two Indifference curve intercept with each other.

In order to prove that two indifference curve do not intercept with each other. Let us draw two Indifference curve (IC1 &IC2)intercepting with each other at point A, As shown in the diagram.

R R1R2 A

IC2IC1

Q Q1Each indifferent curve represents a particular level of

satisfaction to the consumer, which is different from otherIndifference Curve representing different level of satisfaction. If two indifference curve intercepts (as shown in the above diagram)it will corresponding to B and C, managed to equal at some otherpoint A. But is logically meaning less and unacceptable proportion.



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F eatures of P erfect C o m petition. P erfect C o m petition :- A type of market where there are large number of buyers and sellers and no buyer or seller influences the marketindividually.

F eatures of P erfect C o m petition are_ 1. Large number of buyers and sellers:- Perfect competition is a

market where there are large number of buyers and sellers. Thisfeature indicates that both the buyers and sellers do n0t have any major control over the market and they cannot individually influence the market. Thus, it means that quantity supplied by asingle seller is so small that it does not affect the market supply and the price of the commodity produced by hid. Similarly,

quantity demanded by a single buyer does not influence the totaldemand and the price of the commodity.

2. Homogeneous products. A commodity produced by differentproducers is exactly identical in respect of quality, size, price, etc.So a seller has no excuse to charge a higher price for hiscommodity. The buyer also need not discriminate between thesellers.

3. Complete Market information:- According to this feature both the buyers and sellers must have the complete knowledge of market,regarding price, demand and supply situations in the market.

4. Free entry and exist:- Perfect competition allows free entry andexist for the sellers of the commodity under consideration. Thesellers are free to enter the market at any time as per their wishand they also can quit the market whenever they want. There areno legal restrictions on the closing down of the firm.

5. Perfect mobility of factors of production:-It is an important featureof the perfectly competitive markets that all the factors of production like labor and capital are perfectly mobile, bothgeographically and occupationally. If labor and capital are movefrom one place to another as per the requirement of the marketthey are mobile geographically. If labor and capital move from onetype of job or occupation to other type of job easily which means

they are mobile occupationally.

6. No transport Cost:- Perfect competition assumes that there is aabsence of transport cost. This is mainly because the seller willhave no excuse of transport cost to charge a different price.

F eatures of P ure C o m petition. 1. Large number of buyers and sellers.2. Homogeneous products3. Free entry and Exist.



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F eatures of M onopoly m arket. M onopoly :- Monopoly is a type of market in which there is only oneseller producing a commodity having no close substitute.

1. Single Seller:- In this type of market, there is only one sellerproducing a particular commodity.

2. No substitutes:- Monopoly not only implies a single seller butit also means a single seller producing a commodity havingno close substitutes. If the substitutes are available, there will

be a competition among the firms. Monopoly means acomplete absence of competition. So under monopoly, thecommodity has no close substitutes.

3. No distinction between a firm and industry:- Since there isonly one seller of a commodity, there is only one firmproducing that commodity in the market. So there is nodistinction between the concepts of industry and firm undermonopoly.

4. No free entry and exist:- In the monopoly market, there arestrong barriers to the entry of a new firm in t he market. Thisprevents new firms from entering the market and so there isonly one firm producing that commodity.

5. Large number of buyers:- Under monopoly there are largenumber of buyers in the market who compete with oneanother.

6. Downward sloping demand curve:- The demand curve of themonopoly firm slopes downward indicating that themonopolist can maximize sales only by reducing the price.

F eatures of M onopolistic C o m petition. M onopolistic co m petition :- Monopolistic competition refers to amarket where many sellers sell similar but differentiated productto a large number of buyers. In a monopolistic competition market,many monopolistic firms compete with each other by producingsame but differentiated products.

For example, companies selling toothpaste products likeColgate, Pepsodent, Close-up, etc. fall under Monopolisticcompetition.

1. Large number of Sellers:- In a monopolistic competitionmarket, there are large number of sellers. Hence no singleseller can control the market supply. Each seller follows hisown course of action. In other words each seller isindependent.

2. Product differentiation:- Product differentiation is the mostimportant feature of monopolistic competition. Since all



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sellers sell the product which are perfect substitutes for eachother, they go for product differentiation. Every seller makesefforts to show that his product is superior to other product.This differentiation is done through Advertisement, brands,trademarks, designs, packaging, color etc. Thus the productsare not homogeneous under monopolistic competition.

3. Selling costs:- One of the unique features of monopolisticcompetition is its selling cost. Selling cost is the costincurred by the seller on sales promotion activities likeadvertisement, salesmans service etc. Selling cost enablesthe seller to persuade buyers to buy their pro ducts thanproducts from other sellers.

4. Large number of buyers:- There are large number of buyersin a monopolistic competition market. Thus the buyerspurchase goods by choice and not by chance.

5. Free exist and entry:- There is free entry and exist of firmsunder monopolistic competition. There are no barriers forthe firm to enter. Since each firm produces a product whichis little different from others, there is no possibility of morefirms entering the market.

6. Competition :- Competition under monopolistic market ismore as all the firms sell close substitutes. But thecompetition is in two dimensional:1. Price Competition under which the firms were compete

with each other by reducing their products price.2. Non-price competition under which they compete through

advertisement, and sales promotion activities, etc.

F eatures of O ligopoly. O ligopoly :- Oligopoly is an important form of imperfectcompetition. In the word Oligopoly Oligo means few and polymeans seller. Oligopoly therefore refers to the mar ket structurerepresenting few sellers or firms.

1. Few Firms:- Oligopoly is the market in which few firmscompete with each other. The simplest model of oligopoly isduopoly. Duopoly is the market structure when only twofirms produce and supply the product. For e.g. Coke andPepsi.

2. Nature of the product: In an oligopoly market, all the few firms produce an identical product. Such an oligopoly marketis called Pure Oligopoly. On the other hand, firms withproduct differentiation constitute imperfect oligopoly.

3. Interdependence of Firms: In an oligopoly market, there is



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S cope and M eaning of E cono m ics :- The subject of economics is concerned with the satisfaction of

human materialistic wants. It also deals with economic problemsthat arise out of making a choice. These are choice of goods andchoice of technique. The problem of choice of goods arises becau seof _ 1. multiplicity of wants. 2. Wants can be arranged in the orderof their importance. 2. Resources are scarce.

Economic problems relating to choice of technique arise because factor of production have alternative uses. The root causeof an economic problem is the scarcity of resources and the study of economics is concerned with economizing resources. How tomake best uses of resources. Thus according to Somuelson. Thesubject of economics is concerned with a following fundamentalproblem:-

1. What to produce:- This is the major problem in front of thenation. A country has to decide the type of product and theamount of the product to be produced by utilizing the limitedresources as its disposal. Here the firm need to decide

between_a. Choice between Consumption goods and Capital Goods.

b. Choice between Civil goods and War goods.c. Choice between Mass goods and Luxury goods.d. Choice between Private goods and Public goods.

2.

How to produce:- How to produce is essentially a problem of choice of technique. If the country is advanced in itstechnological knowledge then it may produce moreproduction with less fact0r of production and vice versa.

3. For whom to produce:- This is a problem related todistribution of national income among different factors. Inother words it is the problem of how much share each factorshould be provided in return of their services in the processof production.

According to Hipsey besides the above mentionedfundamental problems other important problems are_

1. How to achieve full employment

2.

How to achieve faster growth.3. How to achieve efficiency.4. Productive efficiency.5. Distributive efficiency.

C onclusion : Thus, Scarcity of resources is the root cause of alleconomic problems. The subject economics is concerned

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M eaning of P roduction P ossi b ility C urve A production possibility curve may be defined as a curve which

shows the maximum amount of any two products that can be produced with the given resources and technology. It is also known as Productionpossibility frontier and Transformation Curve.

It is based on the basis of three assumptions:1. The economy operates under full employment and achieves full

production.2. The available supply of factors of production is fixed. Such

resources can be used for different purposes.3. The state of technology remains unchanged during the time of

analysis.Let us illustrate the concept of PPC with the help of the followingschedule and diagram.PPC S chedule :-

Production possibility combinations

Commodity X

Commodity Y

A 0 40B 1 36C 2 30D 3 22E 4 12F 5 0

In the above schedule only a combination of two goods (X&Y) is produced

in the economy with the given resources and technology. When the economy(country) diverts its entire resources to theproduction of Y, it results in the production of 40 units of Y while Xremains Zero. Now, if the society prefers to produce 1 units of X, it has tosacrifice the production of Y by 4. Likewise there can be a number of production possibilities of X and Y in which an increase in the productionof one commodity leads to reduction in the production of anothercommodity.PPC Diagram:

y

40A B

30 C

20 DE

10F

0 1 2 3 4 5 X


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F eatures of F ree M arket E cono m y/ C apitalis m . Free market Economy:- It a system of market mechanism refers to aneconomic system in which all the means of production are privately owned. All economic activities like production, distribution,consumption are very much influenced by the decision taken by thePrivate entrepreneurs.

1. Free enterprise: A market economy is a free enterprise economy where an individual enjoys maximum freedom in economicmatters.

2. Economic freedom: The consumers are allowed free to spend theirincome in whatever manner they decide. The producer is alsoallowed free to choose the products they produce and invest theircapital whatever way they like. But it should not be used opposedto public policy.

3. The role of Government: As the economy is based on freeenterprise, the government does not interfere in economicactivities.

4. Profit motive: Profit motive is the central feature of capitalism. Itacts as an incentive and motivate the entrepreneurs to comeforward and bear risks and uncertainties.

5. Price mechanism: Since government interference is almost notthere, the entrepreneurs had to take decision of

What to produce How to produce For whom to produce

6. Competition:- A market economy is characterized by competition.Competition among entrepreneurs improves the efficiency in theproduction of goods and services.

F eatures of C o mm and econo m y/ S ocialis m / P lanned econo m y There is no specific definition of Command economy. However it can beexplained as A planned economy is one which is run by a single centralplanning authority China is an example of a planned economy.

1. Means of production: Means of production will be owned by thesociety as a whole. They are managed by the state for the benefit of the society. Under socialism, all labourers are employed by thestate. So there is no scope for exploitation of labour.

2. No private property: Means of production cannot be owned by private individuals or associations or individuals.

3. Planning:- The state will decide what to produce where to produce

and how to produce. All the production like agriculture, industry,irrigation and transport will be developed systematically accordingto a well prepared plan.

4. Service motive: Since the production activities are practiced by thestate on behalf of the people. So the main aim is to provide serviceto the people.

5. No Competition: Since all the production activities are taken down by the State there is no competition among the industries.

6. The role of Government: It is fully controlled by the Government.


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F eatures of M ixed E cono m y :Mixed Economy: It is a system in which both capitalist economy andcommand economy exist. It means both private and public sectors co exist and co ordinate. It covers the features of both Capitalism andSocialism.

1. Co-existence of Private and public sectors: Both public and privatesectors exist in a mixed economy. Generally, the public sectorsenter the areas of infrastructure and capital goods industries

which require huge capital and long waiting. The private sectorsenters those areas which are left free by the public sector andparticularly the consumer goods industries. There is also jointsector in which the state joins hands with the private sectors.

2. Operation of Market Mechanism

3. Operation of Government control.4. Economic freedom5. Government regulations6. Planned economy

Distinguish between M arket econo m y and co mm and econo m y.

Market economy (Capitalism) Planned economy (Socialism)1. Definition2. The means of production areowned by the privateenterprises. The decisions of production, distribution,exchange are controlled by theprivate entrepreneurs.3. All economic activities areguided by self interest and profitmotive.4. The decisions of what toproduce, how to produce &

where to produce were mainly inthe hands of Private enterprises.5. Consumer is the king in amarket economy. He can choose

whatever he likes and rejects what he doesnt like. Theproducers are free to invest

wherever they desire.6. Profit motive and privateproperty are the essentialfeatures. It leads to growth of monopolies and high degree of inequality.

1. Definition2. The means of production areowned by the state. All thedecisions regarding production,distribution and exchange aretaken by the state.3. All activities are undertaken

with a view to improve social welfare and to deliver social justice.4. The decisions of what toproduce, how to produce &

where to produce were mainly inthe hands of States.5. Here neither the consumernor the producer is the king.They have no choice but toaccept the decisions taken by theplanners.

6. The major objective of planned economy is to providesocial justice and reduce inequality. It makes all possibleattempts to eliminate monopoly.


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Market economy (Capitalism) Mixed economy(Capital + Social)1. Definition2. The means of production areowned by the privateenterprises. The decisions of production, distribution,exchange are controlled by theprivate entrepreneurs.

3. All economic activities areguided by self interest and profitmotive.

4. The decisions of what toproduce, how to produce &

where to produce were mainly inthe hands of Private enterprises.

5. Consumer is the king in amarket economy. He can choose

whatever he likes and rejects what he doesnt like. Theproducers are free to invest

wherever they desire.6. Profit motive and privateproperty are the essentialfeatures. It leads to growth of monopolies and high degree of inequality.

1. Definition2. The means of production areowned by the private as well asPublic enterprises. The decisionsof production, distribution,exchange are controlled by boththe Private as well as Publicentrepreneurs.3. All economic activities areguided by not only self interestand profit motive but alsoservice oriented.4. The decisions of what toproduce, how to produce &

where to produce were mainly there in the hands of government, which guides bothPublic enterprises as well asPrivate enterprises.5. Here both the consumer andthe producer is the king. But,they have to follow the decisions(law) laid down by thegovernment bodies from time totime.6.Profit motive and privateproperty also Service motive andPublic property are the essentialfeatures.

S hort N ote on M icro econo m ics .Micro economics is the study of particular firms, particular

households, individual prices, wages, income, individual industries,particular commodities.

The above definition gives an idea that, Micro economics isconcerned with the study of the behaviour of the individual units. The

word Micro is derived from the Greek word Mikros meaning small.Hence Micro economics means the study of minute or small parts of theeconomy.S hort N ote on M acro econo m ics .

Macro economics deals not with individual income but with thenational income, not with individual prices but with the price levels, not

with individual prices but with the price levels, not with individual output but with the national output

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can be defined as that branch of economic analysis which studies the behaviour of not one individual unit but all the units combined together.(i.e.) the study of Aggregates.

The word Macro is derived from the Greek word Macrosmeaning large. Hence macro economic is concerned with study of theentire economy. It makes a telescopic approach to study the function of an economy. It deals with aggregates like tota l output, total employment,total savings, total investment, general price level etc. Since Macroeconomics studies the economy in aggregates(large units), it is alsoknown as lumping method.

Macro economics does not deal with the individual parts of theeconomy but with the economy as a whole. It studies the forest as a wholeand not the trees in it.

Micro economics Macro economics1. The concept of Microeconomics deals with the study of individual units likeconsumers, firms etc.2. It is the traditional economicapproach followed by the neo-classical economists.3. Micro economics analysis the

behaviour of micro variablessuch as individual demand,individual supply, price of aparticular product, wages for aparticular worker etc.4. Micro economics is alsocalled as Price theory.5. The scope of microeconomics is limited. It deals

with theory of price and theory of welfare.

1. Macro economics is concerned with the study of aggregates likenational income, employmentetc.2. It is the modern economicapproach followed by moderneconomists like Keynes.3. Macro economics analyses the

behaviour of macro variablessuch as national income,aggregate supply, aggregatedemand, aggregate savings etc.

4. Macro economics is alsocalled as Income theory.5. Macro economics enjoysextensive scope. It is concerned

with monetary theory, incomeand employment theory, publicfinance, international trade,trade cycle, economic growthetc.

C onsu m ers equili b riu m :- A consumer is said to be equilibrium when hegets maximum level of satisfaction by spending his limited income on

purchase of any two goods. A rational consumer will therefore attemptto reach the highest possible indifferent curve and try to obtainmaximum level of satisfaction by spending his limited income.

The conditions or assumption of Consumer Equilibrium are _Consumer equilibrium can be explained by making the following

assumption:-1. A consumer has a scale or preference for different combination of

any two goods and it remain constant throughout the analysis.

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2. A consumer has a fixed amount of income to be spend on any twogoods and he is spent his entire income on the purchase of the twogoods and does not save any part of his income.

3. Prices per unit of two goods X and Y are given and remain constantthroughout the analysis.

4. The two goods are perfectly divisible and substitutable to someextent.

5. All the units of goods are homogeneous.6. Consumer is a rational person & attempts to get maximum level of

satisfaction.

B udget line/ P rice line : Price line represents different combination of any two goods X and Y which the consumer can actually purchase. Assuming

the fixed income of the consumer and price per unit of X and Y is given.Explain how the consumer is reaches his equilibrium combination on hisindifference map. OR explain consumer equilibrium under Indifferencecurve analysis.

In order to explain consumer equilibrium under Indifferencecurve analysis, we have to draw the Indifference Map and theBudget/price line together as shown in the figure below.

Y

A Q

R IC3

EIC2

T IC1s IC0

B X

A rational consumer will try to reach the highest possibleIndifference curve given his income and price per unit of the two goods Xand y.

The consumer will not be equilibrium below the Price line becausehe will not be spending his entire income and he will not get maximumlevel of satisfaction. On the other hand all the combination of X and Y represented by the IC2 and IC3 are ruled out because his income is notsufficient to reach any point on the IC2 and IC3.

The consumer equilibrium should be some where n the Budget lineneither below nor above. E is the equilibrium point. The consumer willnot be equilibrium at any point on the Budget line above the point E

because MRSxy is greater. Similarly, he will not be equilibrium at any

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point below Equilibrium point E on the Budget line Because MRSxy islesser.

Price Elasticity Demand or concepts of Elasticity of DemandThe concept of Price elasticity of demand is introduced by AlfredMarshall. According to Marshall, Price elasticity of demand is the ratioof percentage change in quantity demanded to the percentage change inprice. This is stated in the form of a formula as,

Ep = Percentage change in quantity demandPercentage change in price.

= QP

= Q X PP Q

Where: Ep = Price elasticity of demand.Q = Original demand.

P = Change in price.Inco m e E lasticity of D e m and .

Income Elasticity of Demand refers to the Degree of responsiveness of demand for a commodity due to a change inconsumers income. The formula for measuring income elasticity of demand is as follows.

Ey = Percentage change in the quantity demandedPercentage change in income.

Ey = Q X Y Y Q

Where:- Ey = Income elasticity of demand.Q = original demand

Y = original incomeQ = Change in Demand

Y = Change in Income

P ractical uses of concept of elasticity of D e m and .1. Useful to Businessman:- It guides the businessman in fixing the

price of his goods. He can raise the price of those goods havinginelastic demand and earn more profit. It is very helpful tomonopolists to maximize their profit.

2. Government Taxation Policy: While imposing taxes oncommodities, the Finance Minister has to keep in mind theelasticity of demand for a commodity. If he levies taxes on goods

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3. Price determination of joint products: In case of joint products likecotton and cotton seeds, wool and mutton, etc. it is not possible tocalculate the cost of production separately as they are suppliedtogether. Therefore, the price of each product depends on theelasticity of demand.

4. Determination of wages: Industrial workers get higher wages, if the product produced by them has inelastic demand. Because theproducer is able to pay higher wages by fixing higher price for theproduct which ha inelastic demand. If the demand is elastic, tradeunions cannot get their wages raised.

5. Pricing under monopoly:- Under discriminating monopoly themonopolist charges different prices in different markets on the

basis of elasticity of demand.

43707219 9295316 economics indifference curve

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