Economics Indifference Curve

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M

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 he have to arrange the combination in ascending or descending order of preference. He could tell us that the satisfaction derived from the first combination is more than, equal to or less than from the second combination but not the exact difference (in number) in satisfaction derived from any two combinations. Thus, every consumer arranges these combinations in order of preference. “This conceptual arrangement of combination of goods set in order of level of preference or importance is called the scale of preference.”

INDIFFERENCE CURVE:-

An Indifference curve is the locus of all those combination of any two goods which give the same level of satisfaction to the consumer. (i.e.) He will be indifference between that combination and he does not matter if any combination he gets.

Indifference Schedule:Combinations

Goods (X)

Goods (Y)

A B C D e

1 2 3 4 5

18 13 9 6 4

Level of satisfactions S S S S S

S = Same level of Satisfaction. 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 in further detail as _ To get one more units of X the consumer prefer to give up 5 units or Y. The gain in utility of one additional unit of X will exactly compensated the consumer by the loss of 5 units of Y. Thus the total level of satisfaction from (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 same level of satisfaction they are also known as Iso-utility combination.

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OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M Indifference schedule in Indifference curve as shown below: y P r o d u c t Y

20 15 10 05 0

A

B C

1

2

3

D E IC1 5 x

4

ProductX

In the above figure, X-axis represents product X and Y –axis represents product Y. IC1 is the Indifference curve. All combinations of the goods X & Y represented by points A,B,C,D & E on the Indifferent curve will be equally preferable to the consumer. As these goods gives him the same level of satisfactions.

INDIFFERENCE MAP: An indifference map is consists of a set of indifference curve drawn together. It shows the scale of preference of consumer for different combinations of any two goods. y 20 15 10 05 0

P r o d u c t Y

1

IC3

2

3

IC2 IC1 4

5

x

ProductX

In the indifferent Map given above, all the combination of two goods represented by the curve IC1 will give the consumer the same level of satisfaction. But the level of satisfaction will be less than 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 are labeled in an ascending order such as IC0, IC1, IC2, IC3, IC10, IC100 ……… ICn. Without actual measurement of utility.

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ASSUMPTION OF INDIFFERENCE CURVE ANALYSIS.

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 providing a higher level of satisfaction. 3. It is assumed that utility can be measured in ordinal numbers but not in cardinal measurements. 4. Consumer is rational and his choices are transitive. 5. The consumer behaviour is assumed to be constant, throughout the analysis. 6. Indifference curve analysis assumes diminishing marginal rate of substitution.

Properties of Indifference Curve The indifference curves possess certain characteristics which are also 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 must slopes downwards from left to right y P A r o y1 d B u c IC1 t y2 Y

0

x1

x2

x

ProductX

Indifference curves slopes downwards from left to right indicating that 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) slopes downwards from left to right, shows that as the consumer moves from point 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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OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M Let us see weather, the indifference curve can slope

upwards from left to right or that it is horizontal or vertical as shown in the following figure.

Upward sloping P r o d u c t Y

IC1

Y y2

B

y1

A

0

x1

x2

ProductX

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 consumer tends 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 combination of goods X and Y at point A. This is happening, because the consumer moves from A to B on IC1 consuming more of commodity X [ (i.e.) 0 – x1 to 0 – x2 ] and more of commodity Y [ (i.e.) from 0 – y1 to 0 – y2 ]

Horizontal y

4

P r o d u c t Y

A

B

x1

IC1

x2

x

ProductX


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 goods X 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.

Vertical P r o d u c t Y

IC1

y y2 y1 x1

x

ProductX

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 same quandity of commodity X (i.e.) (0 – x1) From the diagram, it is very clear that, (0 – x1) = (0 – x1) & 5

(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 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}.


Indifference curve must be convex to the origin The 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 the same, from all the successive combinations. Combinations

Goods (X)

Goods (Y)

MRSxy

A B C D e

1 2 3 4 5

18 13 9 6 4

— 5:1 4:1 3:1 2:1

P r o d u c t Y

Y y1 y2 y3

Level of satisfactions S S S S S

A B

C

y4 x1 x2 x3

D

IC1

x4

X

ProductX

Convexity implies that the consumer is willing to give up less of good Y to obtain a little more of good X. This means, a diminishing 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 down the 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. So 6

MRS of X for Y will diminish as the consumer gets more and more of X. Only then the subsequent combinations will give the consumer an equal level of satisfaction. Hence indifference curves are convex to the origin.


No 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 R1 R2

A IC1

IC2

Q Q1 Each indifferent curve represents a particular level of satisfaction to the consumer, which is different from other Indifference 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 other point A. But is logically meaning less and unacceptable proportion.

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Features of Perfect Competition. Perfect Competition:- A type of market where there are large number of buyers and sellers and no buyer or seller influences the market individually.

Features of Perfect Competition are_ 1. Large number of buyers and sellers:- Perfect competition is a market where there are large number of buyers and sellers. This feature 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 a single 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 total demand and the price of the commodity.

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

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 and exist for the sellers of the commodity under consideration. The sellers are free to enter the market at any time as per their wish and they also can quit the market whenever they want. There are no legal restrictions on the closing down of the firm.

5. Perfect mobility of factors of production:-It is an important feature of the perfectly competitive markets that all the factors of production like labor and capital are perfectly mobile, both geographically and occupationally. If labor and capital are move from one place to another as per the requirement of the market

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they are mobile geographically. If labor and capital move from one type 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 a absence of transport cost. This is mainly because the seller will have no excuse of transport cost to charge a different price.

Features of Pure Competition. 1. Large number of buyers and sellers. 2. Homogeneous products 3. Free entry and Exist.


Features of Monopoly market. Monopoly:-

Monopoly is a type of market in which there is only one seller producing a commodity having no close substitute. 1. Single Seller:- In this type of market, there is only one seller producing a particular commodity. 2. No substitutes:-Monopoly not only implies a single seller but it also means a single seller producing a commodity having no close substitutes. If the substitutes are available, there will be a competition among the firms. Monopoly means a complete absence of competition. So under monopoly, the commodity has no close substitutes. 3. No distinction between a firm and industry:- Since there is only one seller of a commodity, there is only one firm producing that commodity in the market. So there is no distinction between the concepts of industry and firm under monopoly. 4. No free entry and exist:- In the monopoly market, there are strong barriers to the entry of a new firm in the market. This prevents new firms from entering the market and so there is only one firm producing that commodity. 5. Large number of buyers:- Under monopoly there are large number of buyers in the market who compete with one another. 6. Downward sloping demand curve:- The demand curve of the monopoly firm slopes downward indicating that the monopolist can maximize sales only by reducing the price.

Features of Monopolistic Competition. Monopolistic competition:- Monopolistic

competition refers to a market where many sellers sell similar but differentiated product to a large number of buyers. In a monopolistic competition market, many monopolistic firms 9

compete with each other by producing same but differentiated products. For example, companies selling toothpaste products like Colgate, Pepsodent, Close-up, etc. fall under Monopolistic competition. 1. Large number of Sellers:- In a monopolistic competition market, there are large number of sellers. Hence no single seller can control the market supply. Each seller follows his own course of action. In other words each seller is independent. 2. Product differentiation:- Product differentiation is the most important feature of monopolistic competition. Since all


3.

4. 5.

6.

sellers sell the product which are perfect substitutes for each other, they go for product differentiation. Every seller makes efforts to show that his product is superior to other product. This differentiation is done through Advertisement, brands, trademarks, designs, packaging, color etc. Thus the products are not homogeneous under monopolistic competition. Selling costs:- One of the unique features of monopolistic competition is its selling cost. Selling cost is the cost incurred by the seller on sales promotion activities like advertisement, salesman’s service etc. Selling cost enables the seller to persuade buyers to buy their products than products from other sellers. Large number of buyers:- There are large number of buyers in a monopolistic competition market. Thus the buyers purchase goods by choice and not by chance. Free exist and entry:- There is free entry and exist of firms under monopolistic competition. There are no barriers for the firm to enter. Since each firm produces a product which is little different from others, there is no possibility of more firms entering the market. Competition :- Competition under monopolistic market is more as all the firms sell close substitutes. But the competition 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.

Features of Oligopoly. Oligopoly :- Oligopoly is an important form of imperfect competition. In the word Oligopoly ‘Oligo’ means few and ‘poly’ 10

means seller. Oligopoly therefore refers to the market structure representing few sellers or firms. 1. Few Firms:- Oligopoly is the market in which few firms compete with each other. The simplest model of oligopoly is duopoly. Duopoly is the market structure when only two firms produce and supply the product. For e.g. Coke and Pepsi. 2. Nature of the product: In an oligopoly market, all the few firms produce an identical product. Such an oligopoly market is called Pure Oligopoly. On the other hand, firms with product differentiation constitute imperfect oligopoly. 3. Interdependence of Firms: In an oligopoly market, there is

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M Interdependence among firms. Thus the move made by one firm to reduce price attracts reaction from other firms. 4. Complex market structure:- The oligopolistic market structure is quite complex. Cartel is an example of collusive oligopoly. The non-collusive oligopoly is the other form of complex market structure. 5. Selling cost:- Advertisement is an important method used by oligopolists to gain larger share in the market. The costs incurred on advertisement are selling costs.

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Scope and Meaning of Economics:-

The subject of economics is concerned with the satisfaction of human materialistic wants. It also deals with economic problems that arise out of making a choice. These are choice of goods and choice of technique. The problem of choice of goods arises because of _ 1. multiplicity of wants. 2. Wants can be arranged in the order of their importance. 2. Resources are scarce. Economic problems relating to choice of technique arise because factor of production have alternative uses. The root cause of an economic problem is the scarcity of resources and the study of economics is concerned with economizing resources. How to make best uses of resources. Thus according to Somuelson. The subject of economics is concerned with a following fundamental problem:1. What to produce:- This is the major problem in front of the nation. A country has to decide the type of product and the amount of the product to be produced by utilizing the limited resources 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 its technological knowledge then it may produce more production with less fact0r of production and vice versa. 3. For whom to produce:- This is a problem related to distribution of national income among different factors. In other words it is the problem of how much share each factor should be provided in return of their services in the process of production. According to ‘Hipsey’ besides the above mentioned fundamental 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.

Conclusion: Thus, Scarcity of resources is the root cause of all economic problems. The subject economics is concerned with economizing resources. 12


Meaning of Production Possibility Curve “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 Production possibility 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 following schedule and diagram.

PPC Schedule:Production possibility combinations

Commodity X

Commodity Y

A B C D E F

0 1 2 3 4 5

40 36 30 22 12 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 the production of Y, it results in the production of 40 units of Y while X remains Zero. Now, if the society prefers to produce 1 units of X, it has to sacrifice 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 production of one commodity leads to reduction in the production of another commodity. PPC Diagram:

y

P r o d u c t Y

40A 30 20 10

B

C D E

13

ProductX

0

1

2

3

4

F 5

X

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M In the diagram, the point A indicates the extreme possibility in which only the commodity Y is produced. The point F indicates other extreme possibility where only the commodity X is produced. Between both extremes we have point B,C,D&E showing different combinations of two goods X and Y. When all the points are joined, we get the curve called production possibility curve(PPC). Production Possibility curve and the most efficient use of resources Or Explain the term Economic Efficiency with the help of PPC. Y P r o d u c t Y

40A 30

B

C

20

D G

10 0

H

1

E 2

3

4

F 5

X

ProductX

Production possibility curve of a society guides how the resources can be most efficiently utilized. A production Possibility curve represents those combinations of two goods (A&B) which can be produced when its resources are most efficiently used. In the above diagram, X-axis represent Commodity X and Yaxis represents Commodity Y. The combinations A,B,C,D,E&F are the attainable combinations while doing most efficient use of resources. But if the economy(country) chooses to Produce combination ‘G’, it leads to inefficient utilization of resources. Since the combination ‘G’ lies below the PPC. It would mean under utilization of resources. If the economy chooses to produce a combination like ‘H’, it would be unattainable under the given resources and technology. Since, the combination ‘H’ lies outside the curve, it would be impossible to attain as the resources are limited.

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Features of Free Market Economy/Capitalism. Free market Economy:- It a system of market mechanism refers to an economic 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 the Private entrepreneurs. 1. Free enterprise: A market economy is a free enterprise economy where an individual enjoys maximum freedom in economic matters. 2. Economic freedom: The consumers are allowed free to spend their income in whatever manner they decide. The producer is also allowed free to choose the products they produce and invest their capital whatever way they like. But it should not be used opposed to public policy. 3. The role of Government: As the economy is based on free enterprise, the government does not interfere in economic activities. 4. Profit motive: Profit motive is the central feature of capitalism. It acts as an incentive and motivate the entrepreneurs to come forward and bear risks and uncertainties. 5. Price mechanism: Since government interference is almost not there, 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 the production of goods and services.

Features of Command economy/Socialism/ Planned economy There is no specific definition of Command economy. However it can be explained as “ A planned economy is one which is run by a single central planning authority China is an example of a planned economy.” 1. Means of production: Means of production will be owned by the society as a whole. They are managed by the state for the benefit of the society. Under socialism, all labourers are employed by the state. 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 according to a well prepared plan.

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


Features of Mixed Economy: Mixed Economy: It is a system in which both capitalist economy and command economy exist. It means both private and public sectors co – exist and co – ordinate. It covers the features of both Capitalism and Socialism. 1. Co-existence of Private and public sectors: Both public and private sectors exist in a mixed economy. Generally, the public sectors enter the areas of infrastructure and capital goods industries which require huge capital and long waiting. The private sectors enters those areas which are left free by the public sector and particularly the consumer goods industries. There is also joint sector in which the state joins hands with the private sectors. 2. Operation of Market Mechanism 3. Operation of Government control. 4. Economic freedom 5. Government regulations 6. Planned economy Distinguish between Market

economy and command

economy. Market economy (Capitalism) 1. Definition 2. The means of production are owned by the private enterprises. The decisions of production, distribution, exchange are controlled by the private entrepreneurs. 3. All economic activities are guided by self interest and profit motive. 4. The decisions of what to produce, how to produce & where to produce were mainly in the hands of Private enterprises. 5. Consumer is the king in a market economy. He can choose whatever he likes and rejects what he doesn’t like. The producers are free to invest

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Planned economy (Socialism) 1. Definition 2. The means of production are owned by the state. All the decisions regarding production, distribution and exchange are taken 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 to produce, how to produce & where to produce were mainly in the hands of States. 5. Here neither the consumer nor the producer is the king. They have no choice but to accept the decisions taken by the planners.

wherever they desire. 6. Profit motive and private property are the essential features. It leads to growth of monopolies and high degree of inequality.

6. The major objective of planned economy is to provide social justice and reduce in equality. It makes all possible attempts to eliminate monopoly.

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M Market economy (Capitalism) 1. Definition 2. The means of production are owned by the private enterprises. The decisions of production, distribution, exchange are controlled by the private entrepreneurs. 3. All economic activities are guided by self interest and profit motive. 4. The decisions of what to produce, how to produce & where to produce were mainly in the hands of Private enterprises.

5. Consumer is the king in a market economy. He can choose whatever he likes and rejects what he doesn’t like. The producers are free to invest wherever they desire. 6. Profit motive and private property are the essential features. It leads to growth of monopolies and high degree of inequality.

Mixed economy(Capital + Social) 1. Definition 2. The means of production are owned by the private as well as Public enterprises. The decisions of production, distribution, exchange are controlled by both the Private as well as Public entrepreneurs. 3. All economic activities are guided by not only self interest and profit motive but also service oriented. 4. The decisions of what to produce, how to produce & where to produce were mainly there in the hands of government, which guides both Public enterprises as well as Private enterprises. 5. Here both the consumer and the producer is the king. But, they have to follow the decisions (law) laid down by the government bodies from time to time. 6.Profit motive and private property also Service motive and Public property are the essential features.

Short Note on Micro economics. “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 is concerned with the study of the behaviour of the individual units. The

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word ‘Micro’ is derived from the Greek word ‘Mikros’ meaning small. Hence Micro economics means the study of minute or small parts of the economy.

Short Note on Macro economics. “ Macro economics deals not with individual income but with the national 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” Macro economics deals with the economic system as a whole. It

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M 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 ‘Macros’ meaning large. Hence macro economic is concerned with study of the entire economy. It makes a telescopic approach to study the function of an economy. It deals with aggregates like total output, total employment, total savings, total investment, general price level etc. Since Macro economics studies the economy in aggregates(large units), it is also known as lumping method. Macro economics does not deal with the individual parts of the economy but with the economy as a whole. It studies the forest as a whole and not the trees in it. Micro economics Macro economics 1. The concept of Micro 1. Macro economics is concerned economics deals with the study with the study of aggregates like of individual units like national income, employment consumers, firms etc. etc. 2. It is the traditional economic 2. It is the modern economic approach followed by the neoapproach followed by modern classical economists. economists like Keynes. 3. Micro economics analysis the 3. Macro economics analyses the behaviour of micro variables behaviour of macro variables such as individual demand, such as national income, individual supply, price of a aggregate supply, aggregate particular product, wages for a demand, aggregate savings etc. particular worker etc. 4. Micro economics is also 4. Macro economics is also called as Price theory. called as Income theory. 5. The scope of micro 5. Macro economics enjoys economics is limited. It deals extensive scope. It is concerned with theory of price and theory with monetary theory, income of welfare. and employment theory, public finance, international trade, trade cycle, economic growth etc.

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Consumer’s equilibrium :- “A consumer is said to be equilibrium when he gets maximum level of satisfaction by spending his limited income on purchase of any two goods”. A rational consumer will therefore attempt to reach the highest possible indifferent curve and try to obtain maximum 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.


2. A consumer has a fixed amount of income to be spend on any two goods and he is spent his entire income on the purchase of the two goods and does not save any part of his income. 3. Prices per unit of two goods X and Y are given and remain constant throughout the analysis. 4. The two goods are perfectly divisible and substitutable to some extent. 5. All the units of goods are homogeneous. 6. Consumer is a rational person & attempts to get maximum level of satisfaction.

Budget line/Price 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 his indifference map. OR explain consumer equilibrium under Indifference curve analysis. In order to explain consumer equilibrium under Indifference curve analysis, we have to draw the Indifference Map and the Budget/price line together as shown in the figure below. Y

P r o d u c t Y

A Q R IC3

E T

IC2 IC1 s IC0

B

X

ProductX

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A rational consumer will try to reach the highest possible Indifference curve given his income and price per unit of the two goods X and y. The consumer will not be equilibrium below the Price line because he will not be spending his entire income and he will not get maximum level 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 not sufficient to reach any point on the IC2 and IC3. The consumer equilibrium should be some where n the Budget line neither below nor above. ‘E’ is the equilibrium point. The consumer will not 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

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M point below Equilibrium point E on the Budget line Because MRSxy is lesser. Price Elasticity Demand or concepts of Elasticity of Demand The concept of Price elasticity of demand is introduced by Alfred Marshall. According to Marshall, “Price elasticity of demand is the ratio of percentage change in quantity demanded to the percentage change in price.” This is stated in the form of a formula as, Ep = Percentage change in quantity demand Percentage change in price. =

Q P

=

Q X P P Q Where: Ep = Price elasticity of demand. Q = Original demand. P = Change in price.

Income Elasticity of Demand. Income Elasticity of Demand refers to the Degree of responsiveness of demand for a commodity due to a change in consumer’s income. The formula for measuring income elasticity of demand is as follows. Ey = Percentage change in the quantity demanded Percentage change in income. Ey

=

Q Y

X Y Q

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

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Q = Change in Demand Y = Change in Income

Practical uses of concept of elasticity of Demand. 1. Useful to Businessman:- It guides the businessman in fixing the price of his goods. He can raise the price of those goods having inelastic demand and earn more profit. It is very helpful to monopolists to maximize their profit. 2. Government Taxation Policy: While imposing taxes on commodities, the Finance Minister has to keep in mind the elasticity of demand for a commodity. If he levies taxes on goods which have elastic demand, it is not profitable for Government.

OM TE X – C LASS ES F.Y.B .CO M E CO NOMI C F.Y.B .CO M 3. Price determination of joint products: In case of joint products like cotton and cotton seeds, wool and mutton, etc. it is not possible to calculate the cost of production separately as they are supplied together. Therefore, the price of each product depends on the elasticity of demand. 4. Determination of wages: Industrial workers get higher wages, if the product produced by them has inelastic demand. Because the producer is able to pay higher wages by fixing higher price for the product which ha inelastic demand. If the demand is elastic, trade unions cannot get their wages raised. 5. Pricing under monopoly:-Under discriminating monopoly the monopolist charges different prices in different markets on the basis of elasticity of demand.

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Economics Indifference Curve

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