Q1: What is a budget line? Why is it downward sloping?
Ans: Budget line is a line showing different combinations of two goods which a consumer can attain, at his given income and market price of the goods,
e.g Px.Qx + PY.Qy=M
It is negatively sloped because consumption of one commodity is associated with the sacrifice of another commodity, i.e. in order to increase consumption of good 1, some units of good 2 has to be sacrificed to be on the same indifference curve.
Q2: Define budget line.
Ans: Budget line is a line showing different combinations of two goods which a consumer can attain, at his given income and market price of the goods,
e.g Px.Qx + PY.Qy=M
Q3: Define a budget line. When can it shift to the right?
Ans: Budget line is a line showing different combinations of two goods which a consumer can attain, at his given income and market price of the goods,
e.g Px.Qx + PY.Qy=M
It can shift to the right due to following reasons:
(i) When the level of income increases.
(ii) When price of both goods falls
Q4: Define budget set.
Ans: Budget set refers to the set of all possible combinations of two goods which a consumer can afford, at his given income and prices in the market
e.g Px.Qx+PY.Qy<M
Q5: Explain the three properties of indifference curve.
Ans: Indifference curve is a curve showing different combinations of two goods, each combination
offering the same level of satisfaction to the consumer.
Properties of indifference curves are:
Q6: What is budget set? Explain what can lead to change in budget set.
Ans: Budget set refers to the set of all possible combinations of two goods which a consumer can afford, at his given income and prices in the market
e.g Px.Qx+PY.Qy<M
Note: A budget line is constructed on the basis of the consumer’s income, price of one good and price of another good. Therefore, if any one of these determinants changes, the budget line changes.
Q7: Explain the concepts of
(i) Marginal Rate of Substitution(MRS)
(ii) Budget line,with the help of numerical examples.
Ans: (i) Marginal Rate of Substitution refers to the rate at which the consumer is willing to substitute one good to obtain one more unit of the other good. Symbolically,
Example Equilibrium is struck at point Q. At the point of equilibrium, price line and indifference curve are tangent to each other implying that the slope of price line
If a consumer wants to have more of X, it reduces the MU of X. Therefore, he will be willing to sacrifice less unit of Y. As he goes on obtaining more and more of X, MU of X starts declining so he will sacrifice less and less of good Y.
(ii) Budget line refers to the bundle of two goods which costs exactly equal to consumer income. The budget line is drawn on the assumptions that price of Good-1 is ? 2 per unit, price of Good-2 is ? 1 per unit and the consumer has ? 60 to spend. Accordingly, maximum 30 units of Good-1 are purchased, when entire budget is spent on Good-1 and maximum 60 units of Good-2 can be purchased, when entire budget is spent on Good
Q8: Explain the conditions of consumer’s equilibrium under indifference curve approach.
or
A consumer consumes only two goods. Explain the conditions of consumer’s equilibrium with the help of indifference curve analysis. (Foreign 2014; All India 2010)
Ans: According to indifference curve analysis, consumer’s equilibrium is at a point where the slope of , indifference curve is equal to the slope of budget line or price line.
Two conditions of the consumer’s equilibrium are.
(ii) At the point of equilibrium, indifference curve must be convex to the origin. It implies that at the point of equilibrium, MRS must be diminishing.
P is the equilibrium point at which budget line touches the higher Indifference Curve IC2 within the consumer budget and /C3 is not affordable curve as his income does not permit, Point A could not be the point of equilibrium because at point A, MRS> Px/Py hence consumer will prefer to consume more of good X and less of good Y, as a result MUX will fall and MUy, will rise, this process will continue till the time MRS = PX/Py.
At point B, MRS <PX/Pyf hence consumer will demand more of good Yand less of good X, MUy will and MUX will rise till the time MRS = Px/Py.
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