Consumer Behaviour

Consumer Behaviour
´ What is the determining factor in the sale of any product in
market?
´ General mills introduced a new breakfast cereal,
Apple Cinnamon Cheerios. However,
The important question is:
How high can you charge the price?
´ The pricing of the food grains to be provided for the people
living below the poverty line also has the same notion.
´ In both these cases, understanding the theory of
consumer behaviour is crucial for decision making.

´ What is consumer Behaviour- The study of how the

consumer with a limited income will decide which
goods and services to buy.
Consumer Behaviour is best explained in three different ways:
´ 1. Consumer Preference: can be explained both graphically and
algebraically.
´ 2. Budget Constraints: Consumers have limited incomes. So prices
play an important role in determining what the consumers buy
´ 3. Consumer Choices: Given preferences and limited incomes,
consumer buy combinations of goods that maximize their level of
satisfaction. Thus, understanding consumer choice will help us
understand demand.
How do consumers decide?

´ Before proceeding, we need to analyse the consumer

preference and whether these assumptions are
actually true.
´ Do you agree that the consumers have preferences
and they buy the products or services based on these
preferences.
´ Are they always rational
´ Behavioural Economics.
´ At this point we make some simplifying assumptions.
However, we also emphasize that this model is
extremely successful in consumer choice and
characteristics of consumer demand.
´ Consumer Preferences:
´ Given vast number of goods and services that our
industrial economy provides for purchase and the
diversity of personal tastes, how do we describe
consumer preferences in coherent way.
´ How consumer might compare different groups of
items.
´ Will one group of items be preferred over the other
group of items.
´ Why are we so obsessed with the analysis of a group
of Items? CPI and WPI
´ Market Baskets: Market basket or bundle describes
the list with specific quantities of one or more goods.
´ How do consumers select monthly market baskets.
´ Food v.s. clothing?
´ To study the theory of consumer behaviour we ask
whether consumers prefer one market basket to
another.
´ Consumer preferences are assumed to be consistent
and making sense.
´ These basic assumptions form the basics of consumer
theory.
´ They do not explain consumer preferences, but they
impose a degree of rationality and reasonableness on
them.
Indifference Curve

´ Indifference curve represents all combination of

market baskets that provide a consumer with the
same level of satisfaction.
´ In order to graph consumer’s indifference curve, it
helps first to graph his or her individual preferences.
´ Following are the features of indifference curve

(a) INDIFFERENCE CURVE ALWAYS SLOPES DOWNWARDS • An indifference curve has a negative slope, i.e. it slopes
FROM LEFT TO RIGHT downward from left to right.
• Reason: If a consumer decides to have one more unit
of a commodity
(say apples), quantity of another good (say oranges)
must fall so that the total satisfaction (utility) remains
same.

(a) INDIFFERENCE CURVE IS ALWAYS CONVEX TO THE ORIGIN • IC is strictly Convex to origin i.e. MRSxy is always
diminishing
• Reason: Due to the law of diminishing marginal utility a
consumer is always willing to sacrifice lesser units of a
commodity for every additional unit of another good.

(c) HIGHER INDIFFERENCE CURVE REPRESENTS • Higher indifference curve represents larger bundles of
goods i.e. bundles which contain more of both or more of
HIGHER LEVEL OF SATISFACTION at least one.
• It is assumed that consumer’s preferences are monotonic
i.e. he always prefers larger bundle as it gives him higher
satisfaction.
´The four properties of indifference curves are:
´ (1) indifference curves can never cross
´(2) the farther out an indifference curve lies, the higher the
utility it indicates
´(3) indifference curves always slope downwards
´(4) indifference curves are convex.
Test Yourself…

´ https://docs.google.com/forms/d/12M8sy4V9bL_STvL--ZDF2Bp5ARCO-
zvrIGA8joKAUyY/edit
Designing new Automobile
´ Suppose you work at ford and are assigned with the task of designing a
new automobile.
´ You have to pick and choose the attributes that you have to modify in the
model and also consider the cost of including these attributes.
´ If you were to design two models Ford mustang vs Ford Explorer what do
you think about the consumer preferences in these two models.
´ Why is the indifference curve sloping downward from left to
right and not upward from A to E.
Ans:(The consumer will be better off at E as he gets more of
both goods which violates the indifference curve basic
assumption of same utility along the curve.)
´ Indifference Maps: Graph containing a set of indifference
curves showing the market baskets among which a consumer
is indifferent.
´ Indifference curves cannot intersect. Why? Which
assumption of consumer theory gets violated? Transitivity
´ Using the assumption on transitivity, the
consumer should be indifferent between B and
D. It actually does not happen.
´ Intersecting Indifference curve contradicts our
assumption that more is preferred to less.
´ There are infinite number of non intersecting
Indifference Curves one for every possible level
of satisfaction. In fact, every possible market
basket has an indifferent curve passing through
it.
 Shape of Indifference Curves:

´ Indifference curves are downward sloping.

´ People face trade-offs.
´ The shape of an IC- How consumer is willing to substitute one good for
another.
´ Ans:The fact that indifference curves slope downward follows directly from
our assumption that more of a good is better than less. If an indifference curve
sloped upward, a consumer would be indifferent between two market baskets
even though one of them had more of both food and clothing.
Marginal Rate of Substitution
´ Maximum amount of a good that a consumer is willing
to give up in order to obtain one additional unit of
another good.
´ What do you mean by (MRS)xy being equal to 3
(willing to give up 3 units of Y to obtain one unit of X)
´ To be consistent, we will define MRS in terms of the
amount of the good on the vertical axis that the
consumer is willing to give up in order to obtain 1 extra
unit of the good on the horizontal axis.
´We add the negative sign in the formula for Marginal
rate of Substitution to make the marginal rate of
substitution a positive number.
´ Why is the numerator negative??
´ Thus, the MRS at any point is equal in magnitude to the slope of the
indifference curve.
´ Convexity: The MRS falls as we move down the indifference curve.
´ The decline in MRS reflects an important characteristic of
consumer preferences that we discussed earlier.
´ The fact that indifference curves slope downward follows directly from
our assumption that more of a good is better than less. If an
indifference curve sloped upward, a consumer would be indifferent
between two market baskets even though one of them had more of both
food and clothing.
DIMINISHING MARGINAL RATE OF
SUBSTITUTION
´ Indifference curves are usually convex, or bowed
inwards.
´ The term convex means that the slope of the
indifference curve (becomes less negative) as we
move down along the curve.
´ In other words, indifference curve is convex if the MRS
diminishes along the curve.
Why is it reasonable to expect Indifference
Curves to be negative?
´ As we move down the Indifference curve and the
consumption of Tea increases, the additional satisfaction that
the consumer gets with one more cup of tea will diminish.
´ Hence, he will now give up less and less biscuits to obtain
more tea.
´ Another way of looking at this is that the consumers prefer
balanced market baskets to the baskets that contain all of
one good and none of other.
Perfect Substitutes and Perfect
Complements.
´ Perfect Substitutes: Two goods for which marginal rate
of substitution of one for other is constant.
´ Indifference curve describing the trade off are the
straight lines.
´ The slope of the indifference curve need not be -1 in
case of perfect substitutes. Why??
´ Because if you plot 8 GB Toshiba Pendrive on Y and 16
GB Sony Pendrive on X. Then 2 units of y will be given
up to gain one unit of X. slope= 2
´ Perfect Compliments: Two goods for which the MRS is
zero or infinite, the indifference curves will be shaped at
right angles.
´ The above mentioned figure gives Jane’s preferences for
the left and right shoes.
´ For her, two goods are perfect complements.
´ Because left shoe will not increase her satisfaction unless
she also obtains the matching right one.
´ Whenever there are more right shoes than left shoes,
Hence (MRS)RL = zero
´ Jane will not give up any left shoes to get additional right
shoes)
´ Whenever there are more left shoes than right shoes,
(MRS)RL = infinite
´ Jane will give up all but one of the excess left shoes in
order to obtain an additional right shoe.
´ How would you carry out the analysis if one of the
products which you are analyzing is considered bad?
´ It becomes difficult to plot hence we would redefine the
product under study so that consumer tastes are
represented as a preference for less of the bad.
´ Hence instead of discussing preference for air pollution
we shall discuss preference for clean air.
´ Not always necessary to associate a numerical level of satisfaction
with each market basket consumed.
´ With respect to the indifference curve, the highest curve describes the
most satisfaction as compared to the one which is lowest.
´ However, by assigning the numerical value we can describe consumer
preferences by assigning scores to the level of satisfaction associated
with each IC.
´ The concept is called utility
´ Utility = level of benefit or satisfaction
´ If buying 3 textbooks gives you more utility than buying a t-shirt, then
we say that 3 books give you more utility than a shirt.
´ If Utility Function is u (F,C)= F+2C
´ Calculate the utility generated by market basket (8 clothes, 3
food)
´ Calculate utility for market basket (4 clothes, 6 food).
´ Which will one prefer?
´ So for one basket to be preferred to the other it should have a
higher number associated.
Indifference curve is also called as iso-utiliy curve

U (F,C)= F*C

When F and C are 5, U1= 25

( can this combination change as long as the U1

Remains 25?)

The numbers attached to the indifference curve

are for convenience only.

Suppose function now is U (F,C)= 4F*C

Then what???
U1= 4* 25
´Important to stress that numbers do not tell us anything.
Only represent ranking.
´We do not know how much one is preferred to another
´If U3= 100 and U2= 50 we only know U3 is better than U2.
´Ordinal Utility Function= Utility function that generates a
ranking of market baskets in order of most to least
preferred.
´Cardinal Utility Function= Utility function describing by
how much one market basket is preferred to another
Ordinal vs Cardinal utility functions
´We will work with only ordinal utility functions.
This approach is sufficient for understanding both how
individual consumer decisions are made and what this
knowledge implies about the characteristics of
consumer demand.
 3.2.Budget Constraint
´ We focused on consumer preferences till now- first element of consumer
theory. (Using Indifference curves)
´ Now move to second element- Budget Constraints that consumers face as
a result of their limited incomes.
´ The Budget Line- All combinations of goods for which the total amount
of money spent is equal to income.
´ Budget line indicates all combinations of F and C for which the total amount
of money spent is equal to income.
´ Ignore the Possibility of saving, Hence consumer spends entire income on
F or C
Pf *F + Pc*C = I
 Pf *F + Pc*C = I… (1)
Pc*C = I - Pf *F
C = I/Pc - Pf *F/Pc … (2)
Y
Simply rearranging,
C - m*x (straight line equation with –ve sign due to slope)
C = (I/Pc) – (Pf /Pc)*F … (3)
Table. 3.2. Market Baskets and Budget Line
Market Basket Food (F) Clothing (C) Total Spending

A 0 40 80

B 20 30 80

D 40 20 80

E 60 10 80

G 80 0 80
´ Why is budget line a straight line: the amount of clothing given up to
obtain additional unit of food remains same along the budget line.
´ ½ units of clothing must be given up to get 1 unit of food.
´ Hence, slope of the line is -1/2
´ It measures the relative cost of food and clothing.
´ Using equation 3.1, we can see how much of C must be given up to
consume more of F.
´ C = (I/Pc) – (Pf /Pc)*F … (3)
´ What is the slope and which one is the vertical intercept?

´ What is slope of the Budget Line?

´ What is slope of the Budget Line?
´ Negative of the ratio of two prices of two goods.
´ Magnitude of the slope tells us the rate at which the two
goods can be substituted for each other without changing the
total amount of money spent.
´ What is represented on the y axis?
´ Ans: (quantity of clothing)
´ What is represented on the x axis?
´ Ans: (quantity of food)
´The Effect of Changes in Income and Prices.
´The budget line depends both on income and on
the prices of the goods, Pf and Pc.
´But both these can change.
´What if the income changes? What about the shifts
of Budget line? Parallel shift
´What if the Prices change? What about the shifts of
budget line? Pivots
´ Income Changes.
´ The vertical intercept of the budget line changes but
the slope of the graph remains unchanged.

´ Price Changes.
´ What if the price of only one good changes, say price
of food falls by 50 % from 1 to 0.50.
´ Slope will change from –Pf/Pc= -1/2 to -0.50/2= -1/4
´ The budget line pivots.
´ The vertical intercept remains unchanged.
´ What happens if the price is doubled?
´ From $1 to $2? The budget line rotates inward to Line
L3, because the persons purchasing power has
diminished.

´ Why does Y intercept remain unchanged? Price of

good plotted on Y axis does not change

´ What if the prices of both food and clothing change

but in a way that leaves the ratio of the two prices
unchanged.
´ What will happen to the slope of the budget line?
Does not change
´ The analysis tells us that purchasing power is determined
not only by income but also by prices.
´ What happens if everything doubles?
´ Prices of both the commodities and also income.
´ The inflationary conditions in which all prices and income
levels rise proportionately will not affect the consumer’s
budget line or purchasing power
´ 3.3 Consumer Choice.
´ Given Preference and budget constraints, we determine
how individual will choose how much of each good to
buy.
´ Assumptions:
´ 1. Rationality
´ 2. They aim to maximize satisfaction given the limited
budget available to them.
´ The maximizing market basket must satisfy two conditions.
´ 1. It must be located on the budget line:
´ Market basket to the left and below the budget line---
´ Market basket to the right of the budget line----
´ Thus, the only rational and feasible choice is a basket on
the budget line.
´ 2. It must give consumer the most preferred combination
of goods and services:
´ These two conditions reduce the problem of maximizing
consumer satisfaction to one of picking an appropriate
point on the budget line.
´ Three indifference curves describe a consumer’s
preference for food and clothing.
´ Remember that of the three curves, the outermost curve
yields the highest amount of satisfaction.
´ Point B is not the most preferred choice, because a
reallocation of income in which more is spent on food and
less is spent on clothing can increase consumer
satisfaction.
´ By moving to point A, consumer spends the same amount
of money and achieves an increased level of satisfaction
associated with U2.
´ Point D yields a higher level of satisfaction but cannot be
purchased with the current income.
´ Hence A maximizes the consumer’s satisfaction.
´The basket which maximizes satisfaction must lie
on the highest IC that touches the budget line.

´At A, slope of the budget line(Pf/Pc)= slope of IC(MRS= - ΔC/ ΔF)

´Hence, the satisfaction is maximized at a point where

MRS = Pf/ Pc
´Satisfaction is maximized :
Marginal rate of Substitution (of Food for
Clothing) is equal to ratio of Prices(of F to C)
´ The equation illustrates the kinds of optimization conditions that arise in
economics.

´ Marginal Benefit= Marginal Cost

´ Marginal benefit- Benefit from consumption of one additional unit of
good.
´ Marginal Cost- Cost of one additional unit of good.
´ The Marginal Benefit is measured by MRS
´ The Marginal Cost is measured by the slope of the budget line.
´ At Point A:
´ Marginal Benefit= Magnitude of Slope of IC= MRS= ½
´ Marginal Cost= Magnitude of Slope of Budget line= ½
MB = MC
´ At Point B:
´ Marginal Benefit= Magnitude of Slope of IC= MRS= 1
MB > MC
´ Marginal Cost= Magnitude of Slope of Budget line= ½
´ If MRS is less or greater than the price ratio, the consumer’s
satisfaction has not been maximized.
´ At point B,
´ Clothing= 30 units
´ Food= 20 Units
´ MRS= 1
´ Price Ratio= ½
´ However, MB > MC (MRS> Price ratio).
´ Hence consumer can substitute one unit of food for one unit of
clothing without any loss of satisfaction.
´ But food is cheaper hence it is in her interest to buy more food.
´ If our consumer purchases 1 unit less of clothing, 2 can be saved and
allocated to food.
´ The reallocation of budget will continue in this manner (moving
along the budget line) until we reach a point A, where the price ratio
of ½ equals the MRS of ½.
´ Only when the condition MRS= ½ =Pf / Pc holds is she
maximizing her satisfaction.
´ Imagining two consumers, the MRS equals the price ratio is a
powerful tool.
´ If the two consumers are maximizing their level of satisfaction,
you can tell the value of each person’s MRS by just looking at the
prices of the two goods.
´ What you cannot tell is the quantities of each good purchased.
That will depend on their relative preferences.
´ Three i
´Designing new Automobiles:
´One potentially profitable option will be to appeal to both
the groups of consumer by manufacturing a model
emphasizing acceleration to a slightly lesser degree than
those preferred in the figure a.
´A second option is to produce a relatively large number of
cars that emphasize size and smaller number emphasizing
acceleration.
Marginal Utility and Consumer Choice

´ Marginal Utility- Additional satisfaction obtained from

consuming one additional unit of a good.
´ We have seen how a consumer will maximize his satisfaction
given the budget constraint.
´ Because the highest indifference curve also has the highest
attainable level of utility.
´Diminishing Marginal Utility:
´Principle that as more of a good is consumed, the
consumption of additional amounts will yield smaller
additions to utility.
´Give an example?
´Consider a small movement down an indifference curve.
The additional consumption of food ΔF will generate
marginal utility MUf.
´Total increase in utility will be Muf * ΔF.
´The reduced consumption of clothing, ΔC, will lower the
utility per unit by MUc, resulting in total loss of Muc * ΔC.
´All points on IC generate the same level of utility, the total
gain in utility associated with the increase in F must
balance the loss due to lower consumption of C.
´Formally,
´0 = MUf (ΔF) + MUc (Δc)
´ Rearranging:
´ - (ΔC/ ΔF) = MUf / MUc
´MRS = MUf / MUc
This value decreases as consumers give up more and more of
C to obtain more of F.
When consumers maximize their satisfaction, the MRS of F
for C is equal to the ratio of the prices of the two goods.
MRS=Pf / Pc
Because MRS is also equal to the ratio of marginal utilities of consuming
F and C, it follows that:
MUf/ MUc= Pf /Pc
Rearranging
MUf/ Pf = MUc /Pc
Utility maximization is achieved when the budget is allocated so that the marginal utility per
dollar of expenditure is same for each good.
As long as the
MU of spending extra dollar on F> MU of spending extra
dollar on c, consumer will buy more food.
Eventually her MUf will diminish (LDMU); and MUc will
rise.
Only when consumer has satisfied the equal marginal
principle- equalized the MU per dollar of expenditure
across all goods- She will have maximized her utility.
Equal Marginal Principle- Principle that utility is
maximized when the consumer has equalized the
marginal utility per dollar of expenditure across all goods
 Individual and Market Demand
We have discussed how the nature of consumer preferences and
budget constraints, consumers will chooses market baskets that
maximize utility.
We analyze now
How demand for a good depends on:
1. The price of product
2. Price of other goods
3. Income of the consumer.
Individual Demand
How demand curve of an individual consumer follows from the
consumption choices that a person faces with a budget constraint.
Previously, We observe how consumer chooses the consumer basket on
the highest IC that touches the Budget line.
Later we examine how the budget line shifts:
1. In response to price changes.
2. In response to income changes.
Price Changes:
Price Consumption Curve: Curve tracing the Utility Maximizing
combinations of two goods as the price of one changes.
Fig. 4.1shows the consumption choices that the consumer makes while
allocating the fixed amount of income between two goods.
Price of Food = $1
Price of Clothes = $2
Consumer’s income is $20
Check the diagram
Start with U2. (What are the quantities of food and clothing consumed)
Point G in the figure 4.1 b corresponds to the point B in the figure 4.1
a.
At G, PF= $1, QF= 12
1. Now if the Pf= $2 (It has doubled) At E, PF= $2, QF= 4
The budget line will pivot inwards and the slope will become twice as steep
(compared to U2)
Which is the Utility maximizing IC? Why is it placed at A and not at some
other point? (Price of food increased, quantity consumed fell, lower
Indifference Curve).
What is the combination of food and clothing at A, Which is the corresponding
point on demand curve (4,6) corresponding point- E?

2. Now if the Pf= $50 cents (It has reduced to half) At H, PF= $0.5, QF= 20
The budget line will pivot outwards And the slope will become twice as Flat
(Compared to U2).
Which is the Utility maximizing IC? Why is it placed at D and not at some
other point? food price falling leads to increased consumption of both
(Higher IC).
As the price of the good falls, the attainable combination of utility
increases as consumer buys more food.
This increased consumption of a good in response to decrease in prices
ALMOST always holds.
Why almost? Because more and more you consume, your utility
diminishes.
How do you decipher if the consumption of clothing increases or
decreases?
The figure shows that it may either increase or decrease. (will depend
whether the good is a normal or inferior good)
The consumption of both can increase because decrease in price of food
has increased consumer’s ability to purchase both goods.
INDIVIDUAL DEMAND
Curve relating the quantity of a good that a single consumer will buy to
its price.
It has 2 imp properties:
1. The level of Utility that can be attained changes as we move along
the curve. (Lower the price of the product, higher the level of
Utility, higher indifference curve is reached as price falls)
2. At every Point on the demand curve, the consumer is maximizing
utility by satisfying the condition that the MRS of food for
clothing equals the ratio of prices of food and clothing. (As the
price of the food falls, the price ratio and the MRS also falls
which implies that relative value of food falls as consumer buys
more of it!)
MRS- The maximum amount of one good that the consumer is
willing to give up in order to buy more of another good.
Thus, as we move down the demand curve the MRS falls. Likewise, the
value that the consumer places on an additional unit of food also falls
from $2 to $1 to $0.50.
Income Changes:
Income Consumption Curve: Curve tracing the utility maximizing
combinations of two goods as a consumer’s income changes.
Lets See what happens when the income changes.
Price of Clothing= $2, Price of Food=$1. Income changes appear as
changes in the budget line.
First Consumer’s income is $10 (F=4, C=3) Shown at point E on
Demand curve (D-curve)
Now, Income increases to $20. (F=10, C=5) Shown at point G on D-
curve)
Now, Income increases to $30. (F=16, C=7)
Shown at point H on D-curve), The ICC is upward sloping
denoting???
The ICC has a positive slope in case of Normal goods.
vIn case of Price changes (other things
held constant) as seen previously-
movement along the DD curve.

vIn case of change in consumer income

(other things held constant) as seen in
case of ICC- shift of the demand curve.
 Giffen vs Inferior Goods
Inferior good is a good whose demand increases when the consumer's
income decreases and whose demand decreases as the consumer's income
increases. For example, second hand cars So, inferiority, in a sense, refers
to the easy affordability of the good at lower consumer income, compared to
the costly substitute.
Giffen good is a special type of inferior good whose demand increases as
the price of the good increases (effective consumer income decreases due to
price increase). An example could be rice which is a staple food of a region
and majority of the food consumption is rice that cannot be substituted.
The difference between the two is that while all giffen goods are inferior, all
inferior goods are not necessarily giffen.
Inferior goods ought to have a costly substitute. On the other hand, for a
good to be giffen, it should not only be inferior but also:
Lack close substitute goods.
A major share of consumption (or consumer's income).
 Normal versus Inferior Goods
´The income elasticity of demand is the percentage change
in the quantity demanded resulting from 1 percent increase
in income.
´The ICC has a positive slope in case of Normal goods.
´How about inferior goods?
´The consumption of inferior goods falls when the income
rises.
Engel Curves:
Income Consumption Curves can be used to
construct Engel Curves, which relates the
quantity of good consumed to an individual’s
income.
Substitutes and Compliments:
One way to see whether two goods are compliments or
substitutes is to examine the price-consumption curve
Downward sloping portion on PCC ? Are food and
Clothing Substitutes or compliments???
Upward sloping portion of PCC? Are food and Clothing
Substitutes or compliments???
 NUMERICALS FOR EXAMS

´ Joey’s budget line relating to Goods X and Y has intercepts of 40 units of Good X and 25 units of
Good Y. If the price of Good X is Rs.15, what is Joey’s budget on the two goods? What is the price
of Good Y? What is the slope of the budget line?
´ Assume that Ross has $100 per month to divide between dinners at a Chinese
restaurant, Song Hay and a pizzeria, Pizza Corner. Assume that going to Song
Hay costs $20 and eating at Pizza Corner costs $10. Suppose Ross has 2 dinners
at Song Hay and 6 dinners at Pizza Corner.
´ Draw Ross’s budget line and show that he can afford the above combination.
´ Assume that Ross gets a higher pay and can now spend $200 per month. Draw
the new budget constraint.
´ As a result of the income increase, Ross decides to eat 8 times at Song Hay and
4 times at Pizza Corner. Draw the Income Consumption Curve. How would you
classify the two goods i.e. dinners at Song Hay and Pizza Corner?
´ What is Marginal rate of substitution? A consumer’s indifference curve
contains the following market baskets of apples and bananas.

Market Apple Banana MRSab=

Basket (X) (Y) ΔY/ ΔX
1 3 24 -
2 5 18
3 7 13
4 9 9

´ What is the consumer’s marginal rate of substitution at the different

combinations?
´ Why does MRS diminish?
´ If the price ratio between apples and bananas is 2, which combination would
the consumer choose assuming she is rational?
´Monica has a monthly budget of Rs.5000 on food
and clothing. The price of food is Rs.250 and that
of clothing is Rs.100. and her monthly consumption
of food is 10 units and that of clothing is 25 units. If
the MRS of food for clothing (MRSFC) at this level is
3, is Monica at equilibrium. If not, which
commodity should she substitute for the other to
reach equilibrium.
´Rachael’s marginal utilities for 2 goods X and Y
are given as follows.
´MUX = 60 – 6 X; MUY = 12 – 3 Y. What is the MRS
when she is at a combination of
´X = 8 and Y = 2. If PX is Rs.30 and PY = Rs.15, is the
combination a consumption equilibrium?
´ It is given that the price of goods X and Y are both Rs.10 each, a consumer consumes 10 units of X and 10 units of Y at
equilibrium.

´ Draw the budget line and indifference curve and show the point of consumer equilibrium.

´ If the price of X falls to Rs.5, PY and money income remaining the same, what is the real income increase?
´ At the new equilibrium caused by a fall in price of X, the consumer has a combination of 16 units of X and 12 units of Y. Show the
price effect of a change in price of X using the PCC.
´Derive Engel’s curve from the income consumption
curve for
´Necessity b) luxury good
´Illustrate and explain the decomposition of price
effect into income effect and substitution effect.