E-LESSON-6 MICRO ECONOMICS

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BBA/BCOM 2 All right are reserved with CU-IDOL Microeconomics Course Code: BBA103/BCM103 Semester: First e-Lesson: 6 SLM Unit: 6 www.cuidol.in Unit-6(BBA103/BCM103)

MICRO ECONOMICS 33 OBJECTIVES INTRODUCTION Students will be able to Describe the concept of In this unit we are going to learn about indifference curve Indifference Curve Student will be able to understand the concept of Under this you will be able to understand budget lines. the properties of indifference curve. Student will be able gain knowledge about Students will be able to understand the consumer equilibrium concept of consumer equilibrium Student will be able to know about how can maximum satisfaction be achieved from monetary income www.cuidol.in Unit-6(BBA103/BCM103) INSTITUTE OF DISTANACEll ArNigDhtOaNrLeINreEsLeErAvRedNIwNiGth CU-IDOL

TOPICS TO BE COVERED 4  Ordinal Utility Analysis  Indifference Curve.  Properties of Indifference curve.  Budget line  Consumer Equilibrium www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

ORDINAL UTILITY ANALYSIS 5 The concept of Cardinal Utility was used by Marshal to define Consumer's Equilibrium. Cardinal Utility means consumer could measure the satisfaction derived by the consumption of any goods or services in terms of number and unit of that measurement is “Utils” or the Money. Where as Ordinal Utility means giving the rank to the utility derived by the consumption of goods and services. This Concept was given by J.R. Hicks. This is more realistic and better than cardinal utility. This is totally based on Introspection. Ordinal utility function is a function representing the preferences of an agent on an ordinal scale. Ordinal utility theory claims that it is only meaningful to ask which option is better than the other. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

INDIFFERENCE CURVE ANALYSIS 6 In microeconomic theory, an indifference curve is a graph showing different bundles of goods between which a consumer is indifferent. That is, at each point on the curve, the consumer has no preference for one bundle over another. One can equivalently refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer. • In other words an indifference curve is the locus of various points showing different combinations of two goods providing equal utility to the consumer. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

ASSUMPTIONS INDIFFERENCE 7 CURVE ANALYSIS 1. Consumer is rational or Rationality 2. Utility is ordinal 3. Consistence in choice 1. If A > B, then never become B > A 4. Consumer’s Preference is Transitive: 1. If A > B and B > C, then A > C 5. Diminishing Marginal Substitution of goods: 6. Dependent Utility 7. A Large bundle of goods preferred to small bundle www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

INDIFFERENCE SCHEDULE 8 According to Watson, “An indifference schedule is a list of combinations of two commodities the list being so arranged that a consumer is indifferent to the combinations, preferring none of any other.” The following is an imaginary indifference schedule representing the various combinations of goods X and Y. Combination Oranges Apples MRS A 1 10 10:1 B 26 4:1 C 33 3:1 D 41 2:1 www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

INDIFFERENCE CURVE 9 An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility.  Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

MARGINAL RATE OF 10 SUBSTITUTION  Marginal Rate of Substitution: The rate at which one good must be added when the other is taken away in order to keep the individual indifferent between the two combinations.  Why MRS diminishes? MRS falls because of the law of diminishing marginal utility. 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 apple. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

INDIFFERENCE MAP 11  An indifference map is a complete set of indifference curves.  It indicates the consumer’s preferences among all combinations of goods and services.  The farther from the origin the indifference curve is, the more the combinations of goods along that curve are preferred. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

PROPERTIES OF INDIFFERENCE 12 CURVES Indifference curves are always convex 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. When the consumer consumes more and more of apples, his marginal utility from apples keeps on declining and he is willing to give up less and less of bananas for each apple. Therefore, indifference curves are convex to the origin. It must be noted that MRS indicates the slope of indifference curve. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

Properties of Indifference Curve 13 Indifference curves have the four basic characteristics:  Indifference curves have a negative slope Indifference curves are convex to the origin Indifference curves do not intersect nor are they tangent to one another. Upper indifference curves indicate a higher level of satisfaction. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

PROPERTIES OF INDIFFERENCE 14 CURVES The indifference curves are not likely to be vertical, horizontal, or upward sloping.  A vertical or horizontal indifference curve holds the quantity of one of the goods constant, implying that the consumer is indifferent to getting more of one good without giving up any of the other good.  An upward-sloping curve would mean that the consumer is indifferent between a combination of goods that provides less of everything and another that provides more of everything.  Rational consumers usually prefer more to less. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

PROPERTIES OF 15 INDIFFERENCE CURVES The slope or steepness of indifference curves is determined by consumer preferences.  It reflects the amount of one good that a consumer must give up to get an additional unit of the other good while remaining equally satisfied.  This relationship changes according to diminishing marginal utility—the more a consumer has of a good, the less the consumer values an additional value of that good. This is shown by an indifference curve that bows in toward the origin. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

PROPERTIES OF INDIFFERENCE 16 CURVES Indifference Curves: No Crossing Allowed!  Indifference curves cannot cross.  If the curves crossed, it would mean that the same bundle of goods would offer two different levels of satisfaction at the same time.  If we allow that the consumer is indifferent to all points on both curves, then the consumer must not prefer more to less.  There is no way to sort this out. The consumer could not do this and remain a rational consumer  Higher indifference curve represents higher satisfaction . This is because the combinations lying on higher indifference curve contain more of either one or both goods and more is always preferred to less. More is preferred to Less Indifference map www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

PROPERTIES OF INDIFFERENCE 17 CURVES Higher Indifference Curves Are Preferred to Lower Ones  Consumers will always prefer a higher indifference curve to a lower one. This is due to the basic economic assumption that “more is always better“.  Just think about it, if someone were to ask you if you wanted a free slice of pizza or an entire pizza for free, what would you say? Who says no to free pizza, right?  Now, of course it’s not always that simple, but in basic economic theory we can assume that consumers have a preference for larger quantities. This is reflected in the indifference curves. The higher the indifference curves are, the larger the quantities of both goods. And thus, the more preferable the indifference curve becomes. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

BUDGET LINE 18  The indifference map only reveals the ordering of consumer preferences among bundles of goods. It tells us what the consumer is willing to buy. It does not tell us what the consumer is able to buy. It does not tell us anything about the consumer’s buying power.  A budget line or price line represents the various combinations of two goods which can be purchased with a given money income and assumed prices of goods\". Combination Biscuit Coffee Income (Y)= 60 A 10 0 Price of Biscuit (Px) = 6 B 8 1 Price of Coffee(Py) = 12 C 6 2 D 4 3 All right are reserved with CU-IDOL E 2 4 F 0 5 www.cuidol.in Unit-6(BBA103/BCM103)

SHIFTS IN THE BUDGET LINE 19 www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

CONSUMER EQUILIBRIUM 20  \"The term consumer’s equilibrium refers to the amount of goods and services which the consumer may buy in the market given his income and given prices of goods in the market, that give maximum satisfaction to consumer\".  The aim of the consumer is to get maximum satisfaction from his money income. Given the price line or budget line and the indifference map: www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

BUDGET LINE SHOULD BE TANGENT 21 TO THE INDIFFERENCE CURVE. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

INDIFFERENCE CURVE SHOULD BE 22 CONVEX TO THE ORIGIN AT THE POINT OF TANGENCY. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

Price Effect 23 A price effect represents change in consumer’s optimal consumption combination on account of change in the price of a good and thereby changes in its quantity purchased, price of another good and consumer’s income remaining unchanged. The consumer is better-off when optimal consumption combination is located on a higher indifference curve and vice versa. The effect on the quantity demanded of a change in its own price is called the price effect. Change in price, in general, exerts two influences on quantity demanded. These two are: Income effect (IE), and the substitution effect (SE). Price Effect = Substitution Effect (SE) + Income Effect (IE). www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

What are Income and Substitution Effects? 24 When the price of q1, p1, changes there are two effects on the consumer.  First, the price of q1 relative to the other products (q2, q3, . . . qn) has changed.  Second, due to the change in p1, the consumer's real income changes. Income effect occurs due to increase (decrease) in real income resulting from a decrease (increase) in the price of a commodity. Substitution effect occurs due to the consumer’s inherent tendency to substitute cheaper goods for relatively expensive ones. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 25 Q1. Indifference curve shows combinations of two goods that: a) would provide the consumer with the same level of satisfaction. b) a consumer could buy with their given income. c) could provide the consumer with similar levels of satisfaction. d) could be available to the consumer in a given time period. Q2. Which of the following statements is NOT TRUE of indifference curves? a) They could intersect. b) They are convex to the origin. c) They exhibit higher levels of utility as you move from the origin. d) They are downward sloping. Answers: 1.a) 2.b) www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 26 Q3. An indifference curve between two commodities where one is a ‘bad’ and the other a ‘good’ would: a) be upward sloping. b) remain downward sloping. c) be vertical to the axis measuring units consumed of the ‘bad’. d) be vertical to the axis measuring units consumed of the ‘good’. Answers: 3. a) www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

Summary 27  Indifference curve :shows all combinations of two goods which yield the same level of satisfaction to the consumer. The consumer is indifferent about any two points lying on this curve.  Budget line: represents different combinations of two goods X and Y which the consumer can buy by spending all his income.  Ordinal Utility Analysis: ordinal utility function is a function representing the preferences of an agent on an ordinal scale. Ordinal utility theory claims that it is only meaningful to ask which option is better than the other.  Consumer Equilibrium :The state of balance obtained by an end-user of products that refers to the number of goods and services they can buy given their existing level of income and the prevailing level of cost prices. Consumer equilibrium permits a customer to get the most satisfaction possible from their income www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

FAQ’S 28 Q1.Define Marginal Rate of Substitution? Ans : Marginal Rate of Substitution: The rate at which one good must be added when the other is taken away in order to keep the individual indifferent between the two combinations. Q2.Discuss the properties of Indifference curve? Ans:-Indifference curves have a negative slope ,Indifference curves are convex to the origin ,Indifference curves do not intersect nor are they tangent to one another,Upper indifference curves indicate a higher level of satisfaction. Q3.Why is an Indifference curve convex to the point of origin? Ans: An indifference curve is convex to the origin because of diminishing MRS. MRS declines continuously because of the law of diminishing marginal utility. When the consumer consumes more and more of apples, his marginal utility from apples keeps on declining and he is willing to give up less and less of bananas for each apple. Therefore, indifference curves are convex to the origin. It must be noted that MRS indicates the slope of indifference curve. www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

REFERENCES 29 1. Salvatore,D.(2012).Managerial Economics: Principles and Worldwide Applications. Oxford: Oxford Press. 2. Ahuja, H. L.(2017).Managerial Economics, New Delhi: S. Chand. 3. Dwivedi, D.N.(2018).Managerial Economics, New Delhi: Vikas Publications. 4. https://www.businesstopia.net/economics/micro/indifference-curve-analysis-concept-assumption- and-properties 5. https://www.toppr.com/guides/business-economics/theory-of-consumer-behavior/indifference- curve/ www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL

30 THANK YOU For queries Email: [email protected] www.cuidol.in Unit-6(BBA103/BCM103) All right are reserved with CU-IDOL