BCOM - Dec 2017 - Sem 1 Bus Eco Answers

December 2017 B.Com. – Year 1 – Semester I – Business EconomicsPart ‘A’ – Each question carries 4 marks – Answer any 5 of the following 8 questions1. Cardinal UtilityAnswerThe Cardinal Utility approach is propounded by neo-classical economists, who believe thatutility is measurable, and the customer can express her/his satisfaction in cardinal orquantitative numbers, such as 1,2,3, and so on.The neo-classical economist developed the theory of consumption based on the assumptionthat utility is measurable and can be expressed cardinally. And to do so, they have introduceda hypothetical unit called as “Utils” meaning the units of utility. Here, one Util is equivalentto one rupee and the utility of money remains constant.Over the passage of time, it was realized that the absolute measure of utility is not possible,i.e. it was difficult to measure the feeling of satisfaction cardinally (in numbers). Also, it wasdifficult to quantify the factors that cause a change in the moods of the consumer, theirtastes and preferences and their likes and dislikes. Therefore, the utility is not measurable inquantitative terms. But however, it is being used as the starting point in the consumerbehavior analysis.The consumption theory is based on the notion that consumer aims at maximizing his utility,and thus, all his actions and doings are directed towards the utility maximization. Theconsumption theory seeks to find out the answers to the following questions: § How does a consumer decide on the optimum quantity of a commodity that he/she wishes to consume? § How consumers allocate their disposable incomes between several commodities of consumption, such that utility is maximized?The cardinal utility approach used in analyzing the consumer behavior depends on thefollowing assumptions to find answers to the above-stated questions: 1. Rationality: It is assumed that the consumers are rational, and they satisfy their wants in the order of their preference. This means they will purchase those commodities first which yields the highest utility and then the second highest and so on. 2. Limited Resources (Money): The consumer has limited money to spend on the purchase of goods and services and thus this makes the consumer buy those commodities first which is a necessity. 3. Maximize Satisfaction: Every consumer aims at maximizing his/her satisfaction for the amount of money he/she spends on the goods and services. 4. Utility is cardinally Measurable: It is assumed that the utility is measurable, and the utility derived from one unit of the commodity is equal to the amount of money, which a consumer is ready to pay for it, i.e. 1 Util = 1 unit of money.

5. Diminishing Marginal Utility: This means, with the increased consumption of a commodity, the utility derived from each successive unit goes on diminishing. This law holds true for the theory of consumer behavior. MUx = f(Qx) The equation states that marginal utility of a commodity X (MUx) is a function of the quantity of X (Qx). 6. Marginal Utility of Money is Constant: It is assumed that the marginal utility of money remains constant irrespective of the level of a consumer’s income. 7. Utility is Additive: The cardinalists believe that not only the utility is measurable but also the utility derived from the consumption of different commodities are added up to realize the total utility.Thus, the cardinal utility approach is used as a basis for explaining the consumer behaviorwhere every individual aims at maximizing his/her utility or satisfaction for the amount ofmoney he spends on the consumption of goods and services.2. Giffen ParadoxAccording to the Law of Demand, when the price of a commodity falls the demand for itrises. Giffen's Paradox is an exception to this law. The paradox is named after the 19thcentury British economist, Sir Robert Giffen, who found that when the price of bread fell,the demand for it also fell.In economics and consumer theory, a Giffen good is a product that people consume more ofas the price rises and vice versa - violating the basic law of demand in microeconomics. Forany other sort of good, as the price of the good rises, the substitution effect makesconsumers purchase less of it, and more of substitute goods; for most goods, the incomeeffect (due to the effective decline in available income due to more being spent on existingunits of this good) reinforces this decline in demand for the good. But a Giffen good is sostrongly an inferior good in the minds of consumers (being more in demand at lower incomes)that this contrary income effect more than offsets the substitution effect, and the net effectof the good's price rise is to increase demand for it.

For almost all products, the demand curve has a negative slope and meets an upwardssloping supply curve at a price point that defines the market for any given good or serviceat a particular moment in time. In other words, price and quantity demanded change inopposite directions; if price goes up, then quantity demanded generally goes down.Giffen goods are an exception to this general rule. Unlike other goods or services, the pricepoint at which supply and demand meet results in higher prices and greater demandwhenever market forces recognize a change in supply and demand for Giffen goods. As aresult, when price goes up, the quantity demanded also goes up. To be a true Giffen good,the good's price must be the only thing that changes to produce a change in quantitydemanded.The classic example given by Marshall is of inferior quality staple foods, whose demand isdriven by poverty that makes their purchasers unable to afford superior foodstuffs. As theprice of the cheap staple rises, they can no longer afford to supplement their diet with betterfoods, and must consume more of the staple food.As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on theresources of the poorer labouring families and raises the marginal utility of money to them somuch that they are forced to curtail their consumption of meat and the more expensivefarinaceous foods: and, bread being still the cheapest food which they can get and will take,they consume more, and not less of it.There are three necessary preconditions for this situation to arise: 1. The good in question must be an inferior good, 2. There must be a lack of close substitute goods, and 3. The goods must constitute a substantial percentage of the buyer's income, but not such a substantial percentage of the buyer's income that none of the associated normal goods are consumed.To understand Demand-Supply relationship, please refer to the video @: 1002