ECO CHAP 2 PPT Grade 11.pptx kdjclknckjsjdc

ECO CHAP 2 PPT Grade 11.pptx kdjclknckjsjdc

1. Clas s 11 Microeconomics

2. Consumer A c onsum e r is o ne who buys goo d s and se r vice s f o r the satisfac t ion of wants. H e takes de c i si o ns with r e gard to t he kind o f goo d s to be purchase d in ord e r to satisfy his wants. The main obj e ct i v e is to get maximum satisfaction from spending his inc o m e on various goo d s and se r vices.

3. Approaches which are Use d to Stu d y Consu m er ‟ s Behaviour The r e are two ma i n approaches to stud y ing consumer‟ s b e havi our a n d consumer‟ s equilibr i u m are : Cardinal Utility Approach (or M a rshall‟s Utility An a lysi s or M a rg i n al Utility Analysis). Ordinal Utility Approach (or Indi f f e r e n c e Curve An a lysi s or H i c k sian Analysis).

4. Cardinal Utility Approach P e ople c o nsume di f fer e nt go o ds and se r vice s in o r der t o m a ximize their satisfaction level. However, to do this, it is nec e ssary t o determine quantum of satisfac t ion obtained fr o m a parti c ula r comm o di t y . Und e r the Cardinal Utility Approach, the c o ncept of “ Ut i lit y ” is use d t o attain the c o nsumer‟s equil i brium.

5. Ut i l i ty Utility refers to want satisfying power of a commodity. It is the satisfaction, actual or expected, derived from the consumption of a commodity. Utility differs from person to person, place to place and time to time. In the words of Prof. Hobson, “Utility is the ability of a good to satisfy a want.” There was no standard unit for measuring utility. So, economists derived an imaginary measure known as „Util‟. Example : Measurement of satisfaction in utils. Suppose you have just eaten an ice-cream and a chocolate. You agree to assign 20 utils as utility derived from the ice-cream. Now the question is : how many utils be assigned to the chocolate? If you liked the chocolate less, then you may assign utils less than 20. However, if you liked it more, you would give it a number greater than 20. Suppose, you assign 10 utils to the chocolate, then it can be concluded that you liked the ice-cream twice as much as you liked the chocolate. Utility can also be measured in terms of money or price, which the consumer is willing to pay. The advantage of using monetary values instead of utils is that it allows easy comparison between utility and price p a id, since bo t h a re in the s a m e units. Example : In the above example, suppose 1 util is assumed to be equal to ₹ 1. Now, an ice-cream will yield utility worth ₹ 20 (as 1 util = ₹ 1) and chocolate will give utility of ₹ 10. This utility of ₹ 20 from the ice-cream of ₹ 10 from the chocolate is termed as value of utility in terms of money. It is impossible to measure the satisfaction of a person as it is inherent to the individual and differs greatly from person to person. Still, the concept of utility is very useful in explaining and understanding the behaviour of consumer.

6. Total Utility : Total utility refers to the total satisfaction obtained from the consumption of all p o s s i bl e u nits of a c o mmo d ity. It measures the total satisfaction obtained from the consumption of all the units of that good. Total utility is zero at zero level of consumption. TU = ∑ MU If the 1 st ice-cream gives you a satisfaction of 20 utils and 2 nd one gives 16 utils, then TU from 2 ice-creams is 20 + 16 = 36 utils. If the 3 rd ice-cream generates satisfaction of 10 utils, then TU from 3 ice-creams will be 20 + 16 + 10 = 46 utils. TU ca n be c a lc u late d as : T U n = U 1 + U 2 + U 3 +.. … + U n Marginal Utility : MU is the additional utility derived from the consumption of one more unit of the given commodity. It is the utility derived from the last unit of a commodity purchased. ∆ 𝑄 MU = ∆ 𝑇 𝑈 OR MU = T U – TU n n - 1 As per given example, when 3 rd ice-cream is consumed, TU increases from 36 utils to 46 utils. The additional 10 utils from the 3 rd ice-cream is the MU. MU of 3 rd ice-cream will be : MU 3 = TU 3 – TU 2 = 46 – 36 = 10 utils Average Utility : AU refers to the per unit satisfaction obtained from the consumption of the particular commodity. AU = 𝑇 𝑈 𝑄

7. Relation s hip Betwee n TU And M U Units Marginal Utility (MU) Total Utility (TU) 1 20 20 2 16 36 3 10 46 4 4 50 5 50 6 -6 44 Ex p lanat i on : TU increases with an increase in consumption of a comm o dity as lon g as MU is pos i tiv e. When TU reaches its maximum, MU becomes zero. This is kno w n a s the ‟Point of S a tiet y ‟. TU curve stops rising at this stage. Wh e n co nsu m pt i on is incre a sed beyond the poin t of satiety, TU starts falling as MU becomes negative. Y Y - v e M U MU X O 50 40 30 20 10 X 50 40 30 20 10 1 2 3 4 5 6 1 2 3 4 5 6 TU M axi m u m T U Total Uti l i ty f rom I ce c r eam M arg i nal U til i ty f rom I ce c r eam Z ero MU U n i ts o f I ce c r eam U n i ts o f I ce c r eam O - 4 -8 Y‟

8. Law of „Diminishing Marginal Utility‟ L aw o f DMU s t ates that as we c o ns u m e mor e and more units of a commodity, the utility derived from each successive unit goes on decreasing. For e x amp l e : Suppos e yo u r f a the r has j u s t c o m e f r om work and you offer him a glass of juice. The first glass of j u ice will g iv e him great s a ti s fa c tion. The s a ti s fa c tion with the second glass of juice will be relatively lesser. With further consumption, a stage will come, when he would not n e ed any mor e gla s s o f jui c e, i.e. when the marginal utility drops to zero. After that point, if he is forced to consume even one more glass of juice, it will lead to di s u tility. Su c h a d ecre a s e in s a ti s fa c tion with consumption of successive units occurs due to 'law of di mi n ishing margina l utility'. Law of DMU has universal applicability and applies to all g o ods and s er vices. It is also known as Gossen‟s first law of consumption as it is give n by a G e rm an H.H . Go s sen.

9. Assumptions of the Law of DMU Cardinal Meas u rement of Utility It is as s umed that utility ca n be m eas u red and a consumer can express his satisfaction in q u antitative terms such a s 1, 2 , 3 e t c . Monetary Mea s ureme n t of Utility It is assumed that utility is measurable in monetary terms. C o nsumption of Reasonable Quantity It is assumed that a reasonable quantity of the com m odity is cons u med. To hold the l aw true, a suita b l e and pro p er quantity of the c om m odity should be consume d . C o n tinuous C o n s umption It is assumed that consumption is a continuous process. N o Chang e in Q u a lity It is as s umed that the quality of the com m odity is u nif orm.

10. Rational Consumer The consumer is assumed to be rational who measures, calculates and compares the utilities of different commodities and aims at maximizing total satisfaction. Independent Utilities It is assumed that all the commodities consumed by a consumer are independent i.e. MU of one commodity has no relation with the MU of another commodity. F u rther, It is als o a s sumed that o ne pe r so n ‟s util i ty is n o t a f f ect e d by t h e utility of any other person. MU of Mone y R emains C o ns t ant As a consumer spends money on the commodity, he is left with lesser money to sp e n d o n o t he r c o m m o dit i es. In th i s p r o cess , t h e r e m ain i ng m o ne y beco m es dea r er to t h e co n sumer and i t i n cre a ses MU o f m o ne y f o r t h e co n sumer. But, such an increase in MU of money is ignored. As MU of a commodity has to be measured in monetary terms, it is assumed that MU of money remains constant. F i xed I n c o m e a n d P r i ces It is assumed that income of the consumer and prices of goods remain constant. Pe r fec t K n o w l e dge It is assumed that the consumer knows the different goods on which his income can be spent and the utility that he is likely to get out of such consumption. It means, that the consumer has perfect knowledge of the various choices available to him.

11. Law of DMU U n its of I c e - C ream Total Utility (in units) Marginal Utility (MU) 1 20 20 2 36 16 3 46 10 4 50 4 5 50 (Poi n t of Sa t iety) 6 44 -6 Explanation : In the above diagram, units of ice cream are shown along X-axis and MU a lo n g t h e Y - a x is. The rectangles (showing each level of satisfaction) become smaller and smaller with an increase in the consumption of ice creams. MU falls from 20 to 16 and then to 10 utils when consumption is i n cre a s ed fro m 1 s t to 2 n d a n d t h en to 3 rd ic e - cre a m. When 5 th is consumed MU = and this point is known as the „Point of Satiety‟. When 6 th ice cream is consumed, MU becomes negative. MU curve slopes downwards showing that the MU of successive units is falling. Y 8 4 X 16 12 Y‟ Z ero MU ( Po i nt o f S atiety ) U n i ts o f I ce C ream 20 B C D E MU M arg i nal u til i ty of I ce c r eam Law of D i minish i n g Marginal Utility A O 1 2 3 4 5 -4 -8 6  N eg ativ e M U

12. More abo u t the Law of DMU MU ma y Increase Init i ally In certain situations, MU may increase but it all depends on the circumstances. Econ o m i sts nor m ally assume that MU conti n uously fa l ls. No Indication about the Rate of Fall in MU It just states that MU falls with an increase in the consump tion of a given com m o d ity. S y no n y m s of the Law of DMU It is also known as the „Fundamental Law of Satisfaction‟ or „Fundamental Psychological Law‟.

13. Consu m er‟s E quilibr i um Equilibrium means a state of rest or a position of no change. A consumer is said to be in equilibrium, when he does not intend to change his level of consumption, i.e., when he derives maximum satisfaction. Consumer Equilibrium refers to the situation when a consumer is having maximum satisfaction with limited income and has no tendency to change his way of existing expenditure. The consumer has to pay a price for each unit of the commodity. So, he cannot buy or consume unlimited quantity. As per the Law of DMU, utility derived from each successive unit goes on decreasing. At the same time, his income also decreases with purchase of more and more units of a commodity. A rational consumer aims to balance his expenditure in such a manner, so that he gets maximum satisfaction with minimum expenditure. Consumer Equilibrium can be discussed under two different situations : If the con s u m er s p ends his entire in c o me on a sin g le com m odi t y ( sin g l e com m odi t y a p p roach ). If a con s umer s p e n ds h is e n tire in c ome on t wo com m odi t ies ( t wo com m odi t y a p p roach).

14. Singl e Co m mo d ity Approach All the assumpti o ns of the Law of D MU are ta k en as assumptions of the consumer‟s equilibrium in the case of a si n gle commo d ity. The number of units t o be consume d of the giv e n commodity by a consumer depends on two factors : Price of the Gi v en C o mm o d i ty. Ex p ected Uti l ity ( Mar g i nal Ut i lity) fro m each successive unit. A consumer in consumptions of single commodity will be at equilibrium when marginal utility (MU X ) is equal to the price paid (P x ) for the commodity i.e. MU x =P X .

15. Cas e 1 If M U x > P x then the consume r is not at equilibrium and he goes on buying because the benefit is greater than the cost. As he buys more , MU fall s because of the operation of the law of diminishing marginal utility. When MU becomes equal to the price, consume r gets the maxi m um benefits and is in equilibrium. Cas e 2 If MU x < P x then also consume r is not at equili b rium as he wi ll have to reduce consump tion of com m o d ity x to raise his total satisfaction till MU becomes equal to price.

16. Consumer‟s Equilibrium in Case of Single Commodity Explanation : From the above schedule and diagram, it is clear that the consumer will be at equilibrium at point „E‟ when he consumes 3 units, because at point „E‟, MU x = P X . A consumer will not consume 4 units as MU of Rs. 4 is less than the price paid of Rs. 10 Similarly, he will not consume 2 units as MU of Rs. 16 is more than the price paid. So, it can be concluded that a consumer in consumption of single commodity (say, x) will be at equilibrium when marginal utility from the commodity (M U x ) i s eq u al to pr i ce ( P x ) pa i d fo r t h e c o mm o d i ty. U n i ts x Pr i ce P x MU (utils) M U x = 1 util = ₹ 1 D i ff ere n ce MU x & P x Remarks 1 10 20 20 ÷ 1 = 20 20 – 10 = 10 M U x > P x M U x > P x So, Consumer will increase the consumption 2 10 16 16 ÷ 1 = 16 16 – 10 = 6 3 10 10 10 ÷ 1 = 10 10 – 10 = C onsu m er ‟ s E q u i l i br i um ( MU x = P x ) 4 10 4 4 ÷ 1 = 4 4 – 10 = - 6 M U x < P x M U x < P x M U x < P x S o, C onsu m er w i ll d e c r e ase the c onsu m p tion 5 10 ÷ 1 = – 10 = - 10 6 10 -6 - 6 ÷ 1 = - 6 - 6 – 10 = - 16 4 U n i ts o f co m m o d i ty X MU and Pri c e of c o mm o di ty X Y X 20 16 12 8 1 2 3 4 5 6 Y‟ C onsu m e r ‟ s E q uili b r i um ( M U x = Px) Z ero MU ( Po i nt o f S atiety ) M U x C o nsu m er’ s E q u i l i br i u m i n c ase o f S i ng l e C o mm o d i ty ( x) E O - 4 -8

17. Two Comm o d i ty Ap p roach The Law of DMU applies in case of either one commodity or one use of a commodity. However, in real life, a consumer normally consumes more than one commodity. In such a situation, 'Law of Equi-Marginal Utility' helps in optimum allocation of his income. It is also known as Gossen‟s Second Law and the Law of maximum satisfaction. According to this approach, a consumer gets maximum satisfaction when ratios of MU of two commodities and their representative prices are equal and MU falls as consumption increases i.e. = MU x MUy P x Py There are two necessary conditions to attain consumer‟s equilibr ium in the cas e of two com m odi t ies : 1) The ratio of Marginal Utility to Price is the same in the case of both the goods. MU x P x = MU y Py

18. MU fal l s as C on s u mpti o n I nc r ea s es : The second condition needed to attain consumer‟s equilibrium is that MU of a commodity must fall as more of it is consumed. If MU does not fall, as consumption increases, the consumer will end up buying only one good which is unrealistic and consumer will never reach the equilibrium position. Case 1: I f 𝐌𝐔𝐱 > 𝐌𝐔𝐲 𝐏𝐱 𝐏𝐲 then the consumer is getting more MU in the case of good X as compared to good Y. T h e r ef o r e , he will b u y m o re of X and le s s of Y. This will lead to fall in MU x and a rise in MU Y . The consumer will continue to buy more of X till 𝐌𝐔𝐱 becomes equal to 𝐌𝐔𝐲 𝐏 𝐱 𝐏𝐲 If 𝑀𝑈𝑥 𝑃 𝑥 < 𝑀𝑈𝑦 𝑃𝑦 then the consumer is getting more MU per rupee in case of good Y as 𝑃 𝑥 𝑃 𝑦 c o mp a red to good X. The r efor e, he w ill b u y mo r e of Y and le s s of X. This will lead to falling in MU Y and a rise in MU x. The consumer will continue to buy more of Y till 𝑀𝑈𝑥 becomes equal to 𝑀𝑈𝑦 . C on c l u s i on : A consumer in consumption of two commodities will be at equilibrium when he spends his limited income in such a way that the ratios of marginal utilities of two commodities and their respective prices are equal and MU falls as consumption increases. Cas e 1 Cas e 2

19. Diagrammatic Explanation with the help of an Example Lest us now discuss the law of equi-marginal utility with the help of a numerical example. Suppose, total money income of the consumer is ₹ 5, which he wishes to spend on two commodities: „x‟ and „y‟. Both these commodities are priced at ₹ 1 per unit. So, consumer can buy maximum 5 units of „x‟ or 5 units of „y‟. In Table, we have shown the marginal utility which the consumer derives from various units of „x‟ and „y‟. C o nsumer’s Equilibrium in cas e of T wo C o m m odi t ies Units MU of com m odi t y „x‟ (in utils) MU of com m odi t y „y‟ (in u t ils) 1 20 16 2 14 12 3 12 8 4 7 5 5 5 3

20. Explanation : From Table, it is obvious that the consumer will spend the first rupee on commodity 'x', which will provide him utility of 20 utils. The second rupee will be spent on commodity 'y' to get utility of 16 utils. To reach the equilibrium, consumer should purchase that combination of both the goods, when : MU of last rupee spent on each commodity is same; and MU f a l l s as con s u m ptio n in c reases. It happens at point E when consumer buys 3 units of 'x' and 2 units of 'y' becau se : MU from last rupee (i.e. 5 th rupee) spent on commodity y gives the same satisfaction of 12 utils as given by last rupee ( i.e. 4 t h rupee) s p ent on com m odi t y x ; a nd MU of each co m m o dity f a l l s as consumptio n in c reases. The total satisfaction of 74 utils will be obtained when consumer buys 3 units of 'x' and 2 units of 'y'. It reflects the state of consumer's equilibrium. If the consumer spends his income in any other order, total satisfaction will be less than 74 utils.

21. Ordinal Utility Approach I n diffe re nce Cu r ve s w as made by J.R. H i ck s an d R.G.D. Allen, popularly known as Hicks and Allen. In 19 3 4, they wro te an article, „A reconstruction of the theo ry of val u e‟ , pres e nting the I n diffe re nce Cu rve Analysis. Mod e rn econ omists disregard e d the concep t of the „cardinal measur e of util i t y ‟. The y we r e of the opinion that utility is a psychological phenomenon an d it is ne xt to impossible to m e asu re utility in absolute terms. According to them, a consumer can rank various combin a tions of goods a nd s e rvices in o r der of his preference. A method of ranking the preferences is known as the „ordinal util i ty approach‟. O rdinal u t i lit y is the utility expressed in r a nks.

22. Ind i fferenc e Curve Indifference Curve refers to the graphical representation of various alternative combinations of bundles of two goods among which the consumer is indifferent. It is a locus of points that show such combinations of two commodities which give the consumer the same satisfaction. Combination of Apples and Bananas A pp le s (A) B ana n as ( B) P 1 15 Q 2 10 R 3 6 S 4 3 T 5 1 Explanation : As seen in the schedule, consumer is indifferent between five combinations of apple and banana. C om b in a tion „ P ‟ (1A + 1 5B) gives the s ame u tility as ( 2 A + 1 B ) , (3 A + 6 B ) and so on. By joining these points, we get an indifference curve IC 1 MRS is t he s l o p e of t he I n d iff e r e n c e C u r v e. Every point on IC 1 represents an equal amount of satisfaction to the consumer. Y 15 X O 6 3 9 12 1 2 3 4 5 P ( 1 A + 1 5 B) Q ( 2 A + 1 0B) R ( 3A + 6B) I n d iffe r e n ce C u rve Ap p l es ( A) Banan as ( B) S ( 4A + 3B ) T ( 5 A + 1 ) IC 1

23. Monotonic Preferences It mean s that a r ati o nal consu m er al w ays prefer s mor e of a com m o d ity as it of f ers him a higher level of satisfaction. It implies that as consumption increases total utility also incr e ases. For Example : Consider 2 Goods : Apples (A) and Bananas (B). Suppose two different bundles are: 1 st : (10 A, 10 B) and 2 nd : (7 A, 7 B). Consumer‟s preference of 1 st bundle as compared to the 2 nd bundle will be called monotonic preference as 1 st bundle contain more of both Apples and Bananas. If 2 bundles are: 1 st : (10 A, 7 B) and 2 nd : (9 A, 7 B). Consumer‟s preference of 1 st bundle as compared to the 2 nd bundle will be called monotonic preference as 1 st bundle contains more of apples, although bananas are same.

24. Indif f erenc e Map It refers to the family of indifference curves that represents consumer preferences over all the bund l es of t wo goods. It represents all the combinations which provide the same level of satisfaction. Eve ry hi g he r or l ow e r l e v e l of satisfaction ca n be s h own on di f fere n t indiffer e n c e curves. Explanation : IC 1 r e p r e sen t s the lowes t s a ti s fa c tion, I C 2 sho w s s a ti s fa c tion mor e than t hat I C 1 and the highe st l e v e l of s a ti s fa c tion is d e p i c t ed by in d iffer e nce c u r v e I C 3 . Ho wev e r, each in d iffe r en c e c u r v e s hows the s a m e l e v e l of s a ti s fa c tion in d ivid u a lly. Higher Indifference Curves represent higher levels of s a ti s fa c tion as h igher in d iffer e nce c u r v e re p re s e n t s la r ger bundles of goods, which means more utility because of monot o nic p r efer e nce. Y O X A IC 3 IC 2 IC 1 B P R C o mm o di ty Y I n di f f erenc e Map S C o mm o d i ty X

25. „Marginal Rate of Substitution‟ It r e fe r s to the rate at whi c h the c o mmo d ities c a n be s u b s tit u ted with each other so that the to t al s a ti s fa c tion of the c o ns u m e r r e main s the s a m e . Combination Ap p l e ( A) Banana (B) MRS AB P 1 15 ---- Q 2 10 5B : 1A R 3 6 4 B : 1A S 4 3 3B : 1A T 5 1 2 B : 1A Explan a tion : AB = 𝐔𝐧𝐢𝐭𝐬 𝐨 𝐟 𝐁𝐚 𝐧 𝐚 𝐧 𝐚𝐬 𝐁 𝐰 𝐢𝐥𝐥𝐢𝐧 𝐠 𝐭𝐨 𝐬𝐚𝐜 𝐫 𝐢𝐟𝐢𝐜𝐞 𝐔𝐧𝐢𝐭𝐬 𝐨𝐟 𝐀𝐩𝐩𝐥𝐞𝐬 𝐀 𝐰𝐢𝐥𝐥𝐢𝐧𝐠 𝐭𝐨 𝐠𝐚𝐢𝐧 OR MRS = ∆ 𝐁 ∆ 𝐀 As seen in the above schedule and diagram, as the consumer moves from P to Q, he sacrifices 5 bananas for 1 apple and MRS comes out to be 5:1. Similarly, from Q to R, MRS AB is 4: 1. The M R S of a p p le s fo r ban a nas i s dimi ni s hin g . M R S mea s ur e s the s l o p e of the indi ffe r e nce cur v e . MRS M R S dim i n i s hes be c a u s e of t he L a w of D M U. In the given example of apples and bananas, Combination „P‟ has only 1 apple and, therefore, apple is relatively more important than bananas. Due to this, the consumer is willing to give up more bananas for an additional apple. But as he consumes more and more of apples, his marginal utility from apples keeps on declining. As a result, he is willing to give up less and less of bananas for each additional apple. 5 B { 4B { 3B { Y X O Q ( 2 A + 1 0B) R ( 3A + 6B) S ( 4A + 3B) Ap p l es ( A) Banan as ( B) 12 9 6 3 T ( 5 A + 1 ) IC 1 MR S bet w een A pp l e an d B a n an a I C 1 i s con v ex sha p ed du e to 15 P ( 1 A + 1 5 B ) d imi n i shi n g M R S 2B { 1B { 1 2 3 4 5

26. Assumptions and Properties of the Indifference Curve T w o Commodities It is assumed that the consumer has a fixed amount of money, whole of which is to be spent on the two goods, given constant prices of both the goods. Non-Satiety It is assumed that the consumer has not reached the point of saturation. Consumer always prefer more of both commodities. Ordinal Utility Consumers can rank their preferences based on the satisfaction from each bundle of goods. Dimin ishing Marginal R a te of Sub s t itu t ion Indifference curve analysis assumes diminishing marginal rate of substitution, due to this assumption, an indifference curve is convex to the origin. Rational Consumer The consumer is assumed to behave in a rational manner, i.e. he aims to maximize his total satisfaction.

27. Properties of Indifference Curve Indi ffer e nce Curv e s are Al w a y s Conv e x to the Origin : An indifference curve is convex to the origin because of diminishing MRS. MRS declines continuously because of the law of diminishing marginal utility. MRS indicates the slope of indifference curve. In d iffer e nce C u rv e Slopes D o w nw a r d s : It implies that as a consumer consumes more of one good, he must consume less of the other good. It happens because if the consumer decides to have more units of apple, he will have to r e duce the c o ns u m p tion of b a nanas, so that to t al s a ti s fa c tion r e main s the s a m e . Higher Indifference Curves Represent Higher Levels of Satisfaction : Higher indifference curve represents large bundle of goods which means more utility because of monotonic preference. Indifference Curves can Never Intersect Each Other : As two indifference curves cannot represent the same level of satisfaction, they c a n n ot inte r se c t each other . It means only one indifference curve will pass through a given point on an indifference map.

28. Y X O Ap p les Bananas A C B IC 2 IC 1 Indi ffer e nce Curv e s I C 1 and IC c an ne v er 2 int e rsect each other A n Ind i fferen c e Curv e Ca n never touch X - axis o r Y - axis : If t h e i n d if f erence curv e touches Y - axis, it w o ul d mea n t h at the consumpti o n of commo d ities on the X - axis i s zero. If t h e i n d i f ferenc e curve touches X - axis, it would mea n that the consumpti o n of commo d ities on the Y - axis is zero. S o , an Indi f ferenc e curv e can never touch any of these axes.

29. Budge t Set It is the set of all possi b l e com b inatio n s of two goods which a consumer can afford with his given inco m e and price s in the market. It is a quantitative com b ination of two goo d s which ca n be purchase d by a consu m er fro m his given inc o me. Equation of a Budget set Where : M = Money Inc o me; Q A = Quant i ty of App l es (A); Q B = Quantity of Bananas (B); P A = Price of each app l e; P B = Price of each Banana .

30. Budge t Line We have discussed different combinations of two goods that provide same level of satisfaction. But, which combination, will a consumer actually purchase, depends upon his income („ c ons u m e r b u dget‟) and p r ices of the t w o commodities. Consumer Budget states the real income or purchasing power of the consumer from which he can purchase certain quantita t iv e b u n d l e s of t w o g o ods at give n p r ice. It means, a consumer can purchase only those combinations (bundles) of goods, which cost less than or equal to his income. Budget line is a graphical representation of all possible combinations of two goods which can be purchased with given income and prices, such that the cost of each of these combinations is equal to the monetary income of the consumer.

31. Sch e dule of B u dget Li n e Suppose , a c o ns u m e r has a b u dget of ₹ 2 to be spe n t on two c o mmo d ities : Ap p l es (A) and Bana n as (B). If apple is priced at ₹ 4 each and banana at ₹ 2 each, then the consumer can determine the various combinations (bundles), which form the budget line. The possible options of spending income of ₹ 20 are given in Table. Combination Apples ( R s .4 each) Bananas ( R s .2 each) Income ( Y ) = 2 E 5 5 × 4 + × 2 = 2 F 4 2 4 × 4 + 2 × 2 = 2 G 3 4 3 × 4 + 4 × 2 = 2 H 2 6 2 × 4 + 6 × 2 = 2 I 1 8 1 × 4 + 8 × 2 = 2 J 10 × 4 + 10 × 2 = 2 Explanation : T h e n u mbe r of appl e s are t aken on X - axis a n d b a n a n as on t h e Y - axis. At Point „E‟, the consumer can buy 5 apples by spending his entire income of Rs. 20 only on apples. At Point „J ‟ , t h e entir e i n c o m e i s s p ent o n l y on b a n a n a s . By joining other combinations like F, G, H and I, we get a straight line „AB‟ known as Budget Line or Price Line. Every point on this budget line indicates those bundles of apples and bananas, which the consumer can purchase by spending his entire income of ₹ 20 at the given prices of goods. Y X O F E 4 5 G D P o i nt D i nd i c a t e s t h a t i nc o m e i s und e r sp e nt 1 2 3 Budge t L i n e C J Unattainable I Combination H A p p l es ( A) Banan as ( B) 10 8 6 4 2

32. More abo u t Budge t Line Budg et lin e AB slo p es d o w n war d s. Bundle s which cos t e xactly to c o nsumer‟s mo n ey inco m e li e on the budget line. Bun d le s w h ich cos t les s than the consumer‟ s mo n ey inco m e shows unde r - spendi n g and li e inside the budget line. Bun d le s w h ich cos t m o re than the consumer‟ s mo n ey inco m e are not available to t h e consume r and li e outside the budget line.

33. Slop e of a Budge t Line Budg et lin e slo p es d o w n war d s as mor e of one go o d ca n be bought by decreasing some units of the other goo d . Sl o p e of Budge t Line = Units of Bananas B willing to sacrifice = ∆ B Units of Apples A willing to gain ∆ A Price Rati o ind i cate s the slope of the Budg et Li n e therefore it is e qual to the „P r ice Rati o ‟ of two goo d s. Price of Y (Py) = Price Ratio = Price of X (P x ) P x Py

34. Slop e of a budget line is r e presen t ed by the pric e r atio w hich is constan t th r oughout, therefore the budget li n e is a straight li n e. Budge t Line has a negative slope, i.e. it slopes downwards as mor e of one good ca n be bought by decreasing some unit s of the other good. Prop e rti e s of Budge t Li n e Budg et Li n e is Down ward S l o p ing Budg et Li n e is a Stra i ght Li n e

35. Shif t in B udge t Line Budge t Line c a n be s hifted only becau s e of two fac t ors : If the in c ome of a consumer changes If the pric e of t h e commodity changes

36. Cas e 1. If the inco m e of consu m er chan g es : Explanation : With the incr e ase in in c ome, the c onsumer will be a b l e to buy m o re b u ndles of g o ods. It will shift the budget line to the right from AB to A 1 B 1 . Similarly, a decrease in income will lead to a leftw a rd sh i f t in the b udget lin e to A 2 B 2 . O Y X A 1 A A 2 B 2 B 1 B Ap p l es ( A) Banan as ( B) Effect of Ch a nge i n I n c o m e on B u d ge t L i n e Case 2. If the price of a commodity change : Chang e in p r ices o f b o t h com m odi t ies : When price of both the goods change, then the budget line will shift. Fall in prices of both the goods will lead to a rightward shift in Budget Line to A 1 B 1 . On the other hand, rise in prices of both the goods will result in leftward shift in budget line to A 2 B 2 .

37. Change in price of the commodity on the X-axis (Apples) : Exp l an a tion : Wh e n p r ice of apple s f a lls , then new b u dget lin e is re p resent e d by a shift in the bud g et line to the right fr o m „AB‟ to „ A 1 B‟. Simila rly, A rise in the p r ice of apple s will shift the bud g et lin e to w a r ds le f t f r om „AB‟ to „ A 2 B‟. O Y X A 1 A A 2 B A p p l es ( A) Banan as ( B) C h a nge in Pri c e o f Apples Change in price of the commodity on the Y-axis (Bananas) : Exp l an a tion : If the pr i c e of banana incr e a ses then Budget Line shifts le f tward f r om AB to A B 2 . If the price of bananas decreases then Budget Line shifts rightward fr o m AB to AB 1 . O Y X A Ap p l es ( A) Banan as ( B) Ch a nge in Price of Bananas B 1 B B 2

38. Indifference Curv e Analysis Approach Consumer‟s equilibrium refers to a situation, in which a consumer derives maximum satisfaction with no intention to change it and su b ject to gi v en pri ce s and his given income. The poin t of maximu m satis f action is achi e ve d by taking t he Indi f f e r e nce ma p and Budge t Line toge t her. On an in d i f f e rence map , a higher indi f f e rence curve represents a higher level of satisfaction. There f ore, a consume r always tries to remain at the highest possibl e indif f er e nce curve, su b ject to his b udget cons t ra int.

39. Consumer‟s Equilibrium under indifference curve theory must meet the fo l lo w ing two con d itions : a) If there are two gods X and Y then the first condition to be fulfilled is MRS XY = 𝑃 𝑥 𝑃 𝑦 XY 𝑃 𝑦 b) If MRS > 𝑃𝑥 , it means that to obtain one more unit of good X, the consumer is willing to sacrifice more units of good Y as compared to what is required in the market. As c ons u m p tion incr e a s es the s a ti s fa c tion of g o od X fa l l s bec a u se of the L aw o f DMU. As a r e s u lt, MRS fal l s and c o ntin ues to fall till MRS XY = 𝑃 𝑥 𝑃 𝑦 XY 𝑃 𝑦 c) If MRS < 𝑃𝑥 , it means that to obtain one more unit of good X, the consumer is willing to sacrifice less unit of good Y as compared to what is required in the market. It induces the consumer to buy less of X and more of Y. As a result, MRS rises till it becomes equal to the ratio of prices and the equilibrium is established. XY Cas e 1. MRS = Rat i o of price s or 𝑃𝑥 𝑃𝑦

40. Cas e 2 . MRS Continuousl y Falls The second condition for consumer‟s equilibrium is that MRS must be diminishing at the point of equilibrium, i.e. the indifference curve must be convex to the origin at the point of equilibrium. Thus, both the conditions need to be fulfilled for a consumer to be in equilibrium. Explanation : IC 1 , IC 2 and IC 3 are three indifference curves and AB is the b u d get lin e . With the constraint of the budget line, the highest indifference c u r v e, which a c o ns u me r c a n re a c h , is I C 2 . The Budget Line is tangent to the indifference curve IC 2 at point E. This is the point of consumer equilibrium where the consumer p u r c ha s es OM qu a ntity of c o mmo d ity „X‟ and ON qu a ntity of commodity „Y‟. As Budget Line can be tangent to one and only one indifference curve, the consumer maximizes his satisfaction at point E, where both the conditions of the Consumer‟s Equilibrium satisfy i.e. a ) M R S = R atio of pri c e s or 𝑃 𝑥 𝑃 𝑦 XY b ) M R S contin u o u s l y fall s . Y O X F A IC 3 IC 2 IC 1 N B M C o mm o d i ty X C o mm o di ty Y C on s um er’s E q u ili bri u m by I n di f f erenc e C u rve A pp roac h H E G