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# LONG QUESTION # 1:

## Theory of Consumer Behaviour:

Theory of consumer behavior in Economics describes how consumers
allocate incomes among different goods and services to maximize their
utility. ... According to this law, an equal additional unit of a good is consumed,
everything else remaining constant, satisfaction will increase, but at a
diminishing rate.

Assumptions:

1. Rationality:
The consumer is assumed to be rational he aims at the maximization of his
utility, given his income and market prices. It is assumed he has full knowledge
(certainty) of all relevant information.

2. Utility is ordinal:
It is taken as axiomatically true that the consumer can rank his preferences
(order the various ‘baskets of goods’) according to the satisfaction of each
basket. He need not know precisely the amount of satisfaction. It suffices that
he expresses his preference for the various bundles of commodities. It is not
necessary to assume that utility is cardinally measurable. Only ordinal
measurement is required.

## 3. Diminishing marginal rate of substitution:

Preferences are ranked in terms of indifference curves, which are assumed
to be convex to the origin. This implies that the slope of the indifference
curves increases. The slope of the indifference curve is called the marginal
rate of substitution of the commodities. The indifference-curve theory is
based, thus, on the axiom of diminishing marginal rate of substitution.

## 4. The total utility of the consumer depends on the quantities of the

commodities consumed

## 5- Consistency and transitivity of choice:

It is assumed that the consumer is consistent in his choice, that is, if in one
period he chooses bundle A over B, he will not choose B over A in another
period if both bundles are available to him.
LONG QUESTION # 2:

## Equilibrium of the Consumer:

In ordinal utility theory, a consumer shall be in equilibrium where he can
maximize his utility subject to his budget constraint. In other words, where the
indifference curve and the budget line are tangent to each other(i.e their slopes are
equal)the consumer will attain equilibrium.

Assumptions:
The ordinal utility approach is based on the following assumptions:

i. Rationality:
Implies that a consumer is a rational being and aims at maximizing the total
satisfaction given the income and prices of goods and services.

## ii. Ordinal Utility:

Assumes that utility is expressible only in ordinal terms. This implies that a
consumer is only able to express his/her preference for goods.

## iii. Transitivity and Consistency of Choice:

Implies that consumer choices are assumed to be transitive and consistent. The
transitivity of choice means that if a consumer prefers A to B and B to C, he/she
would prefer A to C. On the other hand, the consistency of choice means that if a
consumer prefers A to B in one period, he or she cannot prefer B to A in another
period.

iv. Non-satiety:
Implies that a consumer is assumed to be non-satisfied. In other words, it is
assumed that consumer does not reach the level of satisfaction by consuming a good
and always prefers a large quantity of goods.

## v. Diminishing Marginal Rate of Substitution:

Acts as an important concept in indifference curve analysis. Marginal rate of
substitution implies the rate at which a consumer is willing to substitute one good (X)
for another good (Y), so that the total satisfaction remains the same.
LONG QUESTION # 3:

Indifference Curve:
An indifference curve is the locus of points – particular combinations or bundles
of goods-which yield the same utility (level of satisfaction) to the consumer, so that
he is indifferent as to the particular combination he consumes.
An indifference map shows all the indifference curves which rank the
preferences of the consumer. Combinations of goods situated on an indifference
curve yield the same utility. Combinations of goods lying on a higher indifference
curve yield higher level of satisfaction and are preferred. Combinations of goods on a
lower indifference curve yield a lower utility.
An indifference curve is shown in figure 2.5 and a partial indifference map is
depicted in figure 2.6. It is assumed that the commodities y and x can substitute one
another to a certain extent but are not perfect substitutes.

The negative of the slope of an indifference curve at any one point is called the
marginal rate of substitution of the two commodities, x and y, and is given by the
slope of the tangent at that point.
[Slope of indifference curve] = – dy/dx = MRSx,y
The marginal rate of substitution of x for y is defined as the number of units of
commodity y that must be given up in exchange for an extra unit of commodity x so
that the consumer maintains the same level of satisfaction. With this definition the
proponents of the indifference-curves approach thought that they could avoid the
non-operational concept of marginal utility.
In fact, what they avoid is the assumption of diminishing individual marginal
utilities and the need for their measurement. The concept of marginal utility is
implicit in the definition of the MRS, since it can be proved that the marginal rate of
substitution (the slope of the indifference curve) is equal to the ratio of the marginal
utilities of the commodities involved in the utility function

## Furthermore, the indifference-curves theorists substitute the assumption of

diminishing marginal utility with another which may also be questioned, namely the
assumption that the indifference curves are convex to the origin, which implies
diminishing MRS of the commodities.
LONG QUESTION # 4:

Production Function:
Production Function refers to the functional relationship between the quantity of
a good produced (output) and factors of production (inputs). ... It shows the flow of
inputs resulting into a flow of output during some time.

expressed as:

Q = f( L, C, N )

## Where Q = Quantity of output

L = Labour

C = Capital

N = Land.

Hence, the level of output (Q), depends on the quantities of different inputs (L, C, N)
available to the firm. In the simplest case, where there are only two inputs, labour (L)
and capital (C) and one output (Q), the production function becomes.

Q =f (L, C)

Assumptions:
This production function is based on following assumptions:

## 4- The factor of production are divisible into most viable units.

LONG QUESTION # 5

## Law Of Dimininshing Marginal Return:

Law of diminishing returns explains that when more and more units of a variable
input are employed on a given quantity of fixed inputs, the total output may initially
increase at increasing rate and then at a constant rate, but it will eventually increase
at diminishing rates.

In other words, the total output initially increases with an increase in variable input
at given quantity of fixed inputs, but it starts decreasing after a point of time.

Assumptions:
The assumptions made for the application of law of diminishing returns are as
follows:

## iv. Assumes that input prices are given.

Let us understand the law of diminishing returns with the help of an example.
Suppose a mining organization has machinery as the capital and mine workers as the
labor in the short-run production. For increasing the level of production, it can hire
more workers.

## In such a case, the production function of the organization would be as follows:

Q = f (L), K

Where K is constant

## The different values of Qc can be obtained by substituting different values of L in the

equation of production function.
For example, if L is 10, then the value of Q would be as follows:

Qc = 2200

## This output-labor relationship can be represented in the tabular form of a

production function, which is shown in Following Table:

## In Table-3, total product represents the value of Q (output) obtained by

substituting different values of L in the production function Qc = -L3 + 30L2 +20L.
Marginal product refers to the product obtained by increasing one unit of input. In
present case, the change in total quantity of product by including one more worker
is termed as marginal product of labor.

In Table-3, last column shows the three stages of production, which are explained
as follows:
i. Stage I:
Refers to the stages of production in which the total output increases initially
with the increase in number of labor table-3 shows the increase in marginal product
till the number of workers increased to 10 and 11. The marginal output produced by
tenth and eleventh worker is same, which implies that they yield constant returns.
ii. Stage II:
Refers to the stage in which total output increases but marginal product starts
declining with the increase in number of workers. 1 able-3 shows the declining of
marginal product as the number of workers reaches 12.
iii. Stage III:
Refers to the stages in which the total product starts declining with an increase in
number of workers. As shown in Table-3, the total output reaches to maximum level
at the twentieth worker. After that, the total output starts declining.

## Following Figure shows the graphical representation of the three stages of

production:

There are two types of laws that work in the three stages of production. One is
law of increasing returns in stage I and law of diminishing returns in stage II. There
are several factors that are responsible for the application of these laws. Among
these factors, one of the most important factors for the law of increasing returns is
fixed capital. Less number of labor lead to unutilized capital, because capital is
indivisible.
For example, if the capital-labour ratio is 2:6 and capital is indivisible and labor
hired is less than six, then capital is unutilized. Another important factor responsible
for the increase of labor productivity is division of labor. This can be achieved by
hiring more workers to reach the maximum output or optimum capital-labor ratio.
Beyond the optimum capital-labor ratio, there would be no effect of an increased
labor on the productivity of labor because labor can substitute capital to a limited
extent. This leads to an increase in the number of workers to compensate the
decrease in capital and capital-labor ratio.
SHORT QUESTIONS:

## I- Difference between Input and Output:

In economics, factors of production, resources, or inputs are what is used in the
production process to produce output—that is, finished goods and services.
Output in economics is the "quantity of goods or services produced in a given
time period, by a firm, industry, or country", whether consumed or used for further
production.

## II- Total Product:

Total product is the total quantity of output produced by a firm for a given
amount of inputs. Total product influences the short-run considerations made by a
firm

## III- Average Product:

The quantity of total output produced per unit of a variable input, holding all
other inputs fixed. Average product, usually abbreviated AP, is found by dividing
total product by the quantity of the variable input.

## IV- Marginal Product:

Marginal product is the change in total output as one additional unit of input is
added to production. In other words, it measures the how many additional units will
be produced by adding one unit of input like materials, labor, and overhead.

## V- Theory of Consumer Behaviour:

Theory of consumer behavior in Economics describes how consumers
allocate incomes among different goods and services to maximize their
utility. ... According to this law, an equal additional unit of a good is consumed,
everything else remaining constant, satisfaction will increase, but at a
diminishing rate.

## VI- Equilibrium of the Consumer:

In ordinal utility theory, a consumer shall be in equilibrium where he can
maximize his utility subject to his budget constraint. In other words, where the
indifference curve and the budget line are tangent to each other(i.e their slopes are
equal)the consumer will attain equilibrium.

## VII- Indifference Curve:

An indifference curve is the locus of points – particular combinations or bundles
of goods-which yield the same utility (level of satisfaction) to the consumer, so that
he is indifferent as to the particular combination he consumes.
VIII- Production Function:
Production Function refers to the functional relationship between the quantity of
a good produced (output) and factors of production (inputs). ... It shows the flow of
inputs resulting into a flow of output during some time.

## IX- Law Of Dimininshing Marginal Return:

Law of diminishing returns explains that when more and more units of a variable
input are employed on a given quantity of fixed inputs, the total output may initially
increase at increasing rate and then at a constant rate, but it will eventually increase
at diminishing rates.

X- Isoquant Curve:
“The Iso-product curves show the different combinations of two resources with
which a firm can produce equal amount of product.”
“Iso-product curve shows the different input combinations that will produce a
given output.”

## XI- Marginal Rate of Technical Substitution:

Marginal rate of technical substitution (MRTS) is the rate at which a firm can
substitute capital with labor. It equals the change in capital to change in labor which
in turn equals the ratio of marginal product of labor to marginal product of capital.