NMIMS Global Access

School for Continuing Education (NGA-SCE)

Course: Business Economics
Internal Assignment Applicable for December 2018 Examination

Answer: 1

Marginal Rate of Substitution (MRS)

Marginal rate of substitution is defined as the rate at which a consumer is willing to

substitute a commodity with the other one by maintaining the same level of satisfaction.
MRS of two substitute commodities X and Y can be defined as the quantity of commodity
X required to replace one unit of commodity Y or vice versa, such that the utility derived
from either combinations remain same. It means that a consumer can maintain his
satisfaction at the same level by sacrificing some units of one commodity to get some
other commodity. For example a consumer can sacrifice 2 units of commodity Y to buy
one unit of commodity X.
MRS of X and Y is denoted as ∆Y/∆X as it continues to decreasing as the consumer
continues to substitute Y for X or vice versa. According to Utility Approach MRSy,x or
(MRSy,x) decreases which means that the quantity of a commodity a consumer is willing
to give up for an additional unit of other commodity continues to decrease with each
substitution. The rate at which the consumer substitute commodity Y for commodity X is
grater at beginning, but as the process of substitution continues the rate of substitution
will start diminishing.

Combination Units of Units of Total Utility

Commodity Commodity
Y X
a 40 10 -
b 25 14 15:4
c 17 19 8:5
d 10 27 7:8
e 7 38 3:11
 Diminishing MRS between X and Y
Indifference Combinations Change in Y Change in X MRSy,s
Point X+Y (∆Y) (∆X) (∆Y/∆X)
a 40+10 - - -
b 25+14 -15 4 -3.75
c 17+19 -8 5 -1.6
d 10+27 -7 8 -0.875
e 7+38 -3 11 -0.272

According to above tables, as the consumer moves form combination a to b, he

sacrifices 15 units of commodity Y to get 4 units of commodity Y
Therefore MRSy,x= -15/4
= -3.75
Similarly;
When consumer opt for combination b to c, he sacrifices 8 units of commodity Y and get
5 units of commodity X.
Therefore MSRy,s = -8/7 = -1.6

And similarly going forward when he opts for combination c to d, he sacrifices 7 units of
commodity Y to get 8 Units of commodity X hence MRS y,s = -0.875
And when he moves to option d to e, he sacrifices 3 units of commodity Y to get 11
units of commodity X.
This shows that as the consumer moves down to the indifference point a to b, b to c, c
to d and d to e MRS diminishes to -3.75 to -0.272.
Answer: 2

Demand - In economics demand can be refer as consumer’s willingness and ability to

consume a good. Means demand is a quantity of a product a consumer is willing to buy
at a specific point of time. Demand is consisting of mainly three factors quantity to be
purchased, price at which the commodity to be purchased and the time period when the
commodity is purchased.
An increase in the price of a good will lead to decrease in to quantity demanded by
consumer. Similarly a decrease in cost or price of a good will most likely to increase in
demand of the goods. So the Determinants of the demand of a good are the factors
which influence the decision of an individual to purchase a commodity or service. It is
important for an organisation to understand the relationship between demand and
its determinants to analyze the individual and market demand of a good or service.
The determinants of demand are the factors that causes fluctuations in the economic
demand for a commodity or a service. Demand of a product depends on various
determinants. There are two kinds of determinants of demand (a) Determinants of
Individual Demand (b) Determinants of Market Demand.

Factor Influencing Individual Demand

Price of the Product: This is the main parameter to make decision, if other factors
remains constant, price of the commodity price of a commodity inversely proportionate to
quantity demanded. It means when there is rise in the price of a good or service, the
demand of that product will decrease and if price decreases the demand for tat product
will increase.

Price of Related Goods: The demand for a commodity not only depends on its own price
but also on price of related goods. Related goods are (i) Complementary Goods -
Complementary goods are interrelated. An increase in the price of one commodity will
cause a decrease in the demand of a complementary good. E.g rise in the price of bread
will reduce the demand for Jam. There is an inverse relation between the demand and
price of complimentary goods. (ii) Substitute Goods - Competitive products which can
be used interchangeably and serve the same purpose are called substitute goods. If
prices for one commodity rises, that will cause an increase in the demand of substitute
good. E.g. If the price for Brook bond tea increases then the demand for TATA Tea will
increase.
Income of Consumer: Income and demand are directly proportional to each other.
However, the relationship depends on the type of commodity. Demand for normal things
will rise with the increase in the level of income, whereas demand for inferior goods will
fall and demand for luxury good will increase with the rise in the level of income of
consumer. E.g. If the income level of an individual rises he will stop eating low price rice
and the demand for good quality of rice will increase.

Taste and Preferences: Demand for any good or service depends on the taste and
preferences of consume. It includes habit, custom, fashion, traditions, lifestyle etc.
Customers are also influenced by advertisement, climate, new inventions etc.

Consumer’s expectations: Increase in future income and price of the goods will lead to
an increase in quantity demanded. If consumer thing that there will be a rise in the price
of a good, then the demand for good will increase and if consumer expects that there is
will be a rise in his income then also the demand for goods increase.

Credit Policy: Credit Policy means the terms and conditions of buying goods on credit.
Credit policy of bank and supplier effects the demand of product. Favourable credit
polices increase the demand for expensive durable goods like property, cars etc.

Factors Influencing Market demand

Market demand is defined as the sum of all individual demands for a product per unit of
a time at given price. There are several factors that impact market demand.

Size and Composition of Population: Size of population, age distribution and gender
distribution also determines the market demand of a product. Age distribution of the
population will determine that what kind of goods will be demanded more. If there is more
children in population distribution then demand for kid’s goods will be high like cream
biscuits, chocolates, toys etc.

Income Distribution: Income distribution of a country is also a determinant for market

demand. The higher the national income, the higher will be the demand for goods and
services. Distribution pattern of national income is also an important determinant of a
product. If majority of population belongs to low income group, market demand for normal
goods and inferior goods will be high, whereas demand for luxury goods will be relatively
low.

Climate Factor: The demand for goods is also determined by the climate of the area.
Climate conditions such as cold, hot, humid, rains impacts the demand of a product. In
winters woolen clothes are demanded and in summers ice is very much demanded.

Government Policy: Taxing a commodity by govt. increases its price and demand for
that product will fall. Financial help from govt. increases the demand for commodity by
lowering the price.

Supply It refers to the amount of goods or services that producer or provider is willing to
offer to the market at various prices during a period of time. Price is what is offered to
sale. Supply is a flow, it is a certain quantity per day, per week or per month. Supply is
the fundamental concept that determines the price of a commodity in the market.
The price of a commodity and its quantity supplies is directly positive related.
There are two categories of supply (i) Individual supply – it refers to the willingness of
an individual firm to provide a specific quantity of a good or service over a given period.
(ii) Market supply – it refers to the quantity of a specific good or service that all sellers in
the market in combined are willing to sell.

Determinants of the Supply

Supply cannot be remain constant in the market. There are many factors which impact
the supply of goods and services in the market and the factor which impacts the supply
are called determinants of supply.

Price of Product: The most important factor that impact the supply of a product is its own
price. As the price of good increases it will lead to an increase in supply and vice versa,
if the other factors remain constant.
Cost of Production: If there is an increase in production cost, the profit tends to decline,
the supplier will reduce the supply of that commodity. He will not supply the product if the
manufacturing cost is more than market price. Factors that impact cost of production are
labour, bills, raw material etc.

Natural Conditions: Supply of certain goods is directly influenced by climate conditions

such as agricultural products.

Transportation conditions: If there are good transport conditions the supply of goods
will be smooth and if transportation service is not good then even if price of good is higher
the supply will not increase.

Taxation Policy: By imposing taxes on firms the govt. can affect the supply of a
commodity. If the rate of taxes applicable on goods is high then there will be fall in supply.
Similarly subsidies may be given to firms, will increase the supply. Govt. can use its
regulatory device to control activities of a business firm. This will affect the supply.

Production Techniques: Technology has an important impact on the supply of goods.

By using modern technologies, machinery production and productivity can be increased
and average cost of production tends to decrease. This results in the change of quantity
supplied whereas obsolete and old technology results into low production and high cost.

Prices of Related Goods: Supply of a product not only depends on its own price but also
on the price of substitute and complementary goods. E.g. If a company is manufacturing
combs and hair brushes both and suddenly there is a rise price for combs, company will
increase the production for combs and consecutively the supply for hair brushes will
reduce.

Industry Structure: Supply of goods also depends on the structure of industry. If goods
are related to monopoly industry, manufacture may reduce the supply of the goods to
increase the prices and if goods are related to perfectly competitive market, there will w
large no, of sellers so supply will increase.

In the market two terms Demand and Supply play an important role to influence the
decisions of the consumer, supplier and manufacturer. The market is the way in which
economic activities takes place between buyer and seller, through their behaviour and
interaction with each other. Buyer’s as a group determines the overall demand for a
particular product at various prices while sellers as a group determines supply of a
particular product at various prices. The interaction between demand and supply helps in
determining the market equilibrium price of a product. Equilibrium price is when supply
and demand are balance.
Answer: 3

Measurement of Price Elasticity

Price Elasticity of demand is a measure of the degree of change in demand of a

commodity due to the change in price of the commodity. In other words price elasticity of
demand is the rate of change in quantity demanded in response to the change in price.

There are basically four methods of measurement of price elasticity

1. Percentage Method
2. Total Utility Method
3. Arc Method
4. Point Elasticity Method

Assuming that if price of commodity is Rs. 100 then the demand is 400 units and if price
increased to Rs.120 then demand decreased to 250 units. We have to calculate the price
elasticity.

(A) Measurement of price elasticity by using Arc Elasticity Method

This method is used to calculate elasticity of demand at the midpoint of an arc. This
method is used to find out price elasticity of demand over a certain range of price and
quantity.
Formula to calculate price elasticity by Arc Elasticity Method is
∆Q P+P1
ep= X
∆P Q+Q1
Whereas ∆Q is change in Quantity i.e. (Q1-Q)
∆P is change in price i.e. (P1-P)
Q is original quantity demanded, Q1 is new quantity demanded
P is original price, P1 is new price
Here P=100, P1=120; Q=400, Q1=250
 ∆Q P+P1
ep= X
∆P Q+Q1
250−400 100+120
= X
100−20 400+250

−15 22
= X
2 65
= 2.54 appox

As the price and demand inversely related and move in opposing directions. Therefore
the negative sign is ignored. Thus the price elasticity of demand is less than 3.
ep < 3

(B) Calculation of price elasticity using percentage method

This method is also known as ratio method. A ratio of proportionate change quantity
demanded to the price of product is calculated to determine the price elasticity.
Formula for calculating price elasticity by Percentage Method is

Q2−Q1 P2−P1
ep= ÷
Q1 P1

Q1 is original quantity demanded, Q2 is new quantity demanded

P1 is original price, P2 is new price
Here P1=100, P2=120; Q1=400, Q2=250
250−400 120−100
ep= ÷
400 100
−150 20
= ep= ÷
400 100
−3 1
= ep= ÷
8 5
= 1.875 approx
Prices and demand are inversely related and move in opposing directions, hence
negative sign is ignored. Thus the elasticity is greater than 1.
Hence ep > 1