1.

The marginal rate of substitution is the number of units a consumer is willing to give up of
one good in exchange for units of another good and remain equally satisfied. The substitution
doesn't indicate a preference in goods, only that the consumer is willing to give up units of one
good for additional units of another good.
The Marginal Rate of Substitution (MRS) can also be defined as the rate at which a consumer is
ready to exchange a number of units good X for one more of good Y at the same level of utility.
The Marginal Rate of Substitution is used to analyze the indifference curve. This is because the
slope of an indifference curve is the MRS

X Y MRS
40 10 -
25 14 -3.75
17 19 -1.6
10 27 -0.875
7 38 -0.273

The MRS of Good X for Good Y diminishes as more and more of Good X is substituted for
Good Y. In other words, as the consumer has more and more of good X he is prepared to give
up less and less of Good Y.
The rate at which the consumer substitutes Good X for Good Y is greater at the beginning. But,
as he continues the substitution process, the rate of substitution begins to fall.

2. The seven factors which determine the demand for goods are as follows:

1. Tastes and Preferences of the Consumers

2. Incomes of the People

3. Changes in the Prices of the Related Goods

4. The Number of Consumers in the Market

5. Changes in Propensity to Consume

6. Consumers’ Expectations with regard to Future Prices

7. Income Distribution.

Demand schedule and law of demand state the relationship between price and quantity

demanded by assuming “other things remaining the same “. When there is a change in these

other things, the whole demand schedule or demand curve undergoes a change.

The following are the factors which determine demand for goods:
1. Tastes and Preferences of the Consumers:
An important factor which determines demand for a good is the tastes and preferences of the

consumers for it. A good for which consumers’ tastes and preferences are greater, its demand

would be large and its demand curve will lie at a higher level.
2. Incomes of the People:

The demand for goods also depends upon incomes of the people. The greater the incomes of

the people the greater will be their demand for goods. In drawing a demand schedule or a

demand curve for a good we take incomes of the people as given and constant. When as a

result of the rise in incomes of the people, the demand increases, the whole of the demand

curve shifts upward and vice versa.

The greater income means the greater purchasing power. Therefore, when incomes of the

people increase, they can afford to buy more. It is because of this reason that the increase in

income has a positive effect on the demand for a good. When the incomes of the people fall

they would demand less of the goods and as a result the demand curve will shift below.
3. Changes in the Prices of the Related Goods:

The demand for a good is also affected by the prices of other goods, especially those which are

related to it as substitutes or complements. When we draw a demand schedule or a demand

curve for a good we take the prices of the related goods as remaining constant.

Therefore, when the prices of the related goods, substitutes or complements, change the whole

demand curve would change its position; it will shift upward or downward as the case may be.

When price of a substitute for a good fall, the demand for that good will decline and when the

price of the substitute rises, the demand for that good will increase.

The goods which are complementary with each other, the change in the price of any of them

would affect the demand of the other.

4. The Number of Consumers in the Market:

The market demand for a good is obtained by adding up the individual demands of the present

as well as prospective consumers or buyers of a good at various possible prices. The greater

the number of consumers of a good, the greater the market demand for it.
If the consumers substitute one good for another, then the number of consumers of that good

which has been substituted by the other will decline and for the good which has been used in its

place, the number of consumers will increase. Another Important cause for the increase in the

number of consumers is the growth in population.

5. Changes in Propensity to Consume:

People’s propensity to consume also affects the demand for them. The income of the people

remaining constant, if their propensity to consume rises, then out of the given income they

would spend a greater part of it with the result that the demand for goods will increase.

On the other hand, if propensity to save of the people increases, that is, if propensity to

consume declines, then the consumers would spend a smaller part of their income on goods

with the result that the demand for goods will decrease. Thus, with income remaining constant,

change in propensity to consume of the people will bring about a change in the demand for

goods.
6. Consumers’ Expectations with regard to Future Prices:

Another factor which influences the demand for goods is consumers’ expectations with regard to

future prices of the goods. If due to some reason, consumers expect that in the near future

prices of the goods would rise, then in the present they would demand greater quantities of the

goods so that in the future they should not have to pay higher prices.

Similarly, when the consumers hope that in the future they will have good income, then in the

present they will spend greater part of their incomes with the result that their present demand for

goods will increase.

7. Income Distribution:

Distribution of income in a society also affects the demand for goods. If distribution of income is

more equal, then the propensity to consume of the society as a whole will be relatively high

which means greater demand for goods. On the other hand, if distribution of income is more

unequal, then propensity to consume of the society will be relatively less, for the propensity to

consume of the rich people is less than that of the poor people.
Consequently, with more unequal distribution of income, the demand for consumer goods will

be comparatively less. This is the effect of the income distribution on the propensity to consume

and demand for goods. But the change in the distribution of income in the society would affect

the demand for various goods differently.

If progressive taxes are levied on the rich people and the money so collected is spent on

providing employment to the poor people, the distribution of income would become more equal

and with this there would be a transfer of purchasing power from the rich to the poor.

As a result of this, the demand for those goods will increase which are generally purchased by

the poor because the purchasing power of the poor people has increased and, on the other

hand, the demand for those goods will decline which are usually consumed by the rich on whom

progressive taxes have been levied.

Following factors determine supply of goods:

1. Input Prices
If the price of raw materials used in the production of a product goes down, then supply will
increase, i.e., shift to the right. If the price of inputs increase then supply will decrease, shift to
the left.
2. Improvements in technology
If there are any major advancements in technology, then the cost of production will decrease,
and supply shifts to the right.
3. Government Policy
Government policies can have a significant impact on supply. For example: If the government
imposes a subsidy on the good, then supply increases while a tax on the goodwill has the
opposite effect of decreasing supply.
4. Size of the market
If the size of the market increases, then there will likely be an increase in the number of firms in
the market. This increase usually tends to increase supply.
5. Time
Over time, firm can increase capacity and can increase supply.
6. Expectations
The concern about future market conditions can directly affect supply. If the seller believes that
the demand for his product will sharply increase in the foreseeable future, then the firm owner
may immediately increase production in anticipation of future price increases. This increase in
production would shift the supply curve outwards, i.e., increase supply.

3. Percentage Method:
PEd = % change in quantity demanded / % change in price
%age change in quantity demanded = (250-400)/400 = -0.375
%age change in Price = (120-100)/100 = 0.2
PEd = -0.375/0.2 = -1.875
Arc elasticity method:

PEd = (-150 X 220)/(20 X 650) = -2.538