Test: Theory Of Consumer Behaviour- 2 - CA Foundation MCQ

- Total Utility (TU): This is the total satisfaction obtained from consuming 3 units, which is Rs. 5.
- Marginal Utility (MU): The additional satisfaction from consuming one more unit, given as 1 for the last unit.
- Consumer Surplus (CS): It measures the difference between what a consumer is willing to pay and what they actually pay.

To find Consumer Surplus:

- Formula: CS = Total Utility - (Price × Quantity)
- Given: TU = Rs. 5, MU = 1, Quantity = 3
- Price (assumed from MU of last unit): Rs. 1
- CS Calculation: CS = 5 - (1 × 3) = 2

Thus, the consumer surplus is Rs. 2.

Marginal Utility: A Cardinal Concept

Marginal utility is a cardinal concept for the following reasons:

• Quantifiable Measurement: Marginal utility can be measured in numerical terms. It deals with the change in satisfaction derived from consuming an additional unit of a good or service, which can be expressed in cardinal or absolute numbers.
• Diminishing Marginal Utility: According to the law of diminishing marginal utility, the additional satisfaction derived from consuming successive units of a good or service decreases. This decrease can be measured and compared using cardinal numbers.
• Consumer Decision Making: Marginal utility is a crucial concept in understanding consumer behavior and decision making. Consumers are assumed to maximize their utility by allocating their resources to the goods and services that provide the highest marginal utility per unit cost. This decision-making process is based on cardinal utility measurements.

In summary, marginal utility is a cardinal concept because it involves a quantifiable measurement of satisfaction that can be expressed in numerical terms, which is essential in understanding and analyzing consumer behavior and decision making.

The correct answer is B: Ordinal approach.

- Indifference Curve Analysis is based on the ordinal utility concept.
- This approach assumes that consumers can rank preferences but not measure utility in absolute terms.
- Consumers express preferences by ranking different combinations of goods.
- Indifference curves represent combinations of goods providing the same satisfaction level.
- This analysis contrasts with the cardinal approach, which assigns specific numerical values to satisfaction levels.

Law of Diminishing Marginal Utility

• The Law of Diminishing Marginal Utility states that as a consumer consumes additional units of a good or service, the satisfaction (utility) gained from each additional unit decreases.
• It is based on the concept that the total utility increases at a decreasing rate with the consumption of more units of a commodity, eventually reaching a maximum point.
• This law plays an essential role in understanding consumer behavior and helps determine the equilibrium point for a consumer in deciding the quantity to be consumed.
• It also helps to explain the downward-sloping demand curve, as the marginal utility of a good decreases as its quantity increases, leading to a decline in the consumer's willingness to pay for additional units.

In summary, the Law of Equi Marginal Utility and the Law of Diminishing Marginal Utility are two fundamental principles within the Marginal Utility Analysis framework, which helps explain consumer behavior and decision-making processes related to the consumption of goods and services.

• The consumer will adjust their spending based on the marginal utility of different products.
• They will keep shifting their spending from one product to another until they find a point where the last amount spent on each product gives them the same level of satisfaction.
• This situation is referred to as the Law of Equi-Marginal Utility.
• This can be represented as:

Answer: c. L-Shaped Indifference Curve

Explanation:

• Complementary goods are those goods which are consumed together, in fixed proportions, to satisfy a particular want or need. For example, left and right shoes, or a car and its tires.


• Indifference curves represent different combinations of two goods that provide the same level of satisfaction or utility to a consumer.


• In the case of complementary goods, the consumer does not derive any additional satisfaction from consuming more of one good without consuming more of the other good. This means that the consumer is indifferent between different combinations of the two goods only when they are in fixed proportions.


• As a result, the indifference curve for complementary goods takes an L-shape. This is because the consumer will only be willing to trade off one good for the other good at a fixed ratio, and the indifference curve will have a sharp corner (the "L" shape) at that point.


• Convex indifference curves (option A) represent substitutes, where the consumer is willing to trade off one good for the other in varying proportions. Straight-line indifference curves (option B) represent perfect substitutes, where the consumer is willing to trade off one good for the other at a constant rate. Circular indifference curves (option D) are not a realistic representation of consumer preferences, as they would imply infinite satisfaction levels at certain points.

- When two goods are perfect substitutes, the consumer is willing to replace one good with the other at a constant rate.
- This constant rate results in indifference curves that are straight lines, indicating that the consumer's satisfaction remains the same at any point along the line.
- Unlike other shapes, a straight line reflects the equal rate of substitution between the goods, which is characteristic of perfect substitutes.
- Therefore, the correct answer is C: A straight line.

Answer: B. Marginal utility becomes negative. Total utility starts decreasing when marginal utility becomes negative. To understand this, let's break it down:

- Utility: Utility is a measure of the satisfaction or happiness a consumer derives from consuming a good or service.

- Total Utility: Total utility is the total amount of satisfaction derived from the consumption of all units of a good or service.

- Marginal Utility: Marginal utility is the additional satisfaction derived from consuming one more unit of a good or service.

Now, let's discuss the relationship between total utility and marginal utility:
1. When marginal utility is positive: - The consumption of an additional unit of the good or service provides the consumer with additional satisfaction. - Total utility increases as the number of consumed units increases.
2. When marginal utility becomes zero: - The consumption of an additional unit of the good or service provides no additional satisfaction to the consumer. - Total utility remains constant, as the additional unit does not contribute to the overall satisfaction.
3. When marginal utility becomes negative: - The consumption of an additional unit of the good or service reduces the consumer's overall satisfaction. - Total utility starts decreasing, as the additional unit detracts from the overall satisfaction. In conclusion, total utility starts decreasing when marginal utility becomes negative, as consuming more units of the good or service results in a reduction of overall satisfaction.

Explanation: The substitution effect of a fall in the price of a commodity refers to the change in the consumption pattern of a consumer due to the relative price change of the commodity, keeping the level of satisfaction or utility constant. When the price of a commodity falls, the following effects occur: 1. Substitution effect: The consumer substitutes the cheaper commodity for the relatively more expensive commodity. 2. Income effect: The consumer's purchasing power increases due to the fall in price, which may lead to an increase in the consumption of both goods. As a result of these effects, the consumer's consumption pattern changes, and they move to a higher indifference curve (IC), which represents a higher level of satisfaction or utility. Therefore, the correct answer is: C: Movement from lower IC to a higher one.

Explanation: The budget constraint line is a result of all of the factors mentioned in the options. Let's break down each component and how it contributes to the formation of the budget constraint line: Market price of commodity X:

• The price of commodity X determines how much of it a consumer can purchase given their income and the price of other goods.
• If the price of commodity X increases, the consumer will be able to purchase less of it, and the budget constraint line will shift inwards.
• If the price of commodity X decreases, the consumer will be able to purchase more of it, and the budget constraint line will shift outwards.

Market price of commodity Y:

• Similarly, the price of commodity Y affects how much of it a consumer can purchase given their income and the price of other goods.
• If the price of commodity Y increases, the consumer will be able to purchase less of it, and the budget constraint line will shift inwards.
• If the price of commodity Y decreases, the consumer will be able to purchase more of it, and the budget constraint line will shift outwards.

Income of the consumer:

• Income is the amount of money a consumer has available to spend on goods and services.
• If the consumer's income increases, they will be able to purchase more of both commodities, and the budget constraint line will shift outwards.
• If the consumer's income decreases, they will be able to purchase less of both commodities, and the budget constraint line will shift inwards.

In summary, the budget constraint line is a result of the market prices of commodities X and Y, as well as the consumer's income. All of these factors affect the consumer's ability to purchase different combinations of the two commodities, which is represented by the budget constraint line.

Indifference curve analysis is based on:

B: Ordinal analysis Explanation: Indifference curve analysis is a crucial concept in microeconomics, particularly in understanding consumer choice and preferences. It is based on ordinal analysis, and here's why:

- Ordinal utility: Indifference curve analysis is built on the notion of ordinal utility, which means that consumers can rank their preferences for goods and services in order (1st, 2nd, 3rd, etc.), but cannot measure the utility they derive from them in absolute terms (like 10 units, 20 units, etc.). This is different from cardinal analysis, which assumes that consumers can measure their utility in absolute terms.

- Indifference curves: An indifference curve is a graphical representation of a consumer's preferences, showing all the combinations of two goods that provide the same level of satisfaction or utility to the consumer. The consumer is indifferent between any two points on the curve, as they provide the same level of utility. This concept relies on ordinal utility, as the consumer is only ranking their preferences and not assigning a specific value to the utility derived from each combination.

- Marginal rate of substitution (MRS): Indifference curve analysis also considers the marginal rate of substitution, which is the rate at which a consumer is willing to substitute one good for another while maintaining the same level of satisfaction. This concept is based on the ordinal measurement of utility, as it only requires the consumer to rank their preferences for different combinations of goods and not to assign specific utility values to them. In conclusion, indifference curve analysis is based on ordinal analysis, as it revolves around ordinal utility, indifference curves, and the marginal rate of substitution, all of which rely on the consumer's ability to rank their preferences rather than measuring utility in absolute terms.

Answer: A. Declining marginal rate of substitution

Explanation: The convexity of indifference curves is due to the declining marginal rate of substitution (MRS). This can be further explained through the following points:

- Marginal Rate of Substitution (MRS): MRS is the rate at which a consumer is willing to give up one good in exchange for another good while maintaining the same level of satisfaction or utility. In other words, it shows the trade-off between two goods that a consumer is willing to make.

- Diminishing MRS: As a consumer consumes more of one good, the marginal utility of that good decreases, while the marginal utility of the other good increases. This is known as the law of diminishing marginal utility. Due to this, the consumer is willing to give up less of the second good to obtain more of the first good, resulting in a declining MRS.

- Convexity of Indifference Curves: Indifference curves are convex to the origin because of the declining MRS. As a consumer moves along an indifference curve, they are willing to give up fewer units of the second good to obtain more of the first good, resulting in the curve's convex shape. In conclusion, the convexity of indifference curves is a result of the declining marginal rate of substitution, which is due to the law of diminishing marginal utility. This reflects the consumer's willingness to make trade-offs between two goods while maintaining the same level of satisfaction or utility.

Indifference Curves: Convex to the Origin

• Indifference curves are graphical representations of a consumer's preferences over different combinations of goods.
• An indifference curve shows all the combinations of goods that provide the same level of satisfaction or utility to the consumer.
• Indifference curves are convex to the origin because of the principle of diminishing marginal rate of substitution (MRS).
• The MRS is the rate at which a consumer is willing to give up one good for another while maintaining the same level of utility.
• As a consumer consumes more of one good and less of another, the marginal utility of the good being consumed decreases, while the marginal utility of the other good increases, leading to a decreasing MRS.
• Therefore, as the consumer moves along an indifference curve, they are willing to give up smaller and smaller amounts of the other good to gain additional units of the good being consumed, resulting in a convex shape to the origin.

Indifference curves cannot intersect each other as it would break down the indifference curve analysis. This is because the consumer would have more than one point on the indifference curve giving him a different level of satisfaction.

Explanation of the Law of Equi-Marginal Utility:

• The law of equi-marginal utility is an economic concept that states that consumers allocate their income in such a way that the last unit of money spent on each good or service provides the same level of marginal utility.
• This law helps consumers maximize their satisfaction by allocating their income among different goods and services in the most efficient way.
• The key idea behind this law is that consumers should equate the marginal utility per unit of money spent on each good or service.

Price of Money in the Law of Equi-Marginal Utility:

• In the context of the law of equi-marginal utility, the price of money is considered to be one.
• This is because money is the medium of exchange and the unit of account for measuring the value of goods and services in an economy.
• When the price of money is one, it means that the marginal utility of money is constant, allowing consumers to allocate their income efficiently among different goods and services.
• As a result, the consumer can equate the marginal utility per unit of money spent on each good or service, maximizing their overall satisfaction.

In conclusion, the law of equi-marginal utility considers the price of money as one, allowing consumers to efficiently allocate their income among different goods and services to maximize their satisfaction.

Explanation of the answer:

At equilibrium, the consumer achieves the maximum possible satisfaction given their income and the prices of goods. In this situation, the following conditions are met: - The consumer's budget line represents the different combinations of goods they can afford given their income and the prices of goods. - The consumer's indifference curve represents the different combinations of goods that give them the same level of satisfaction.

At equilibrium:

- The slope of the indifference curve is equal to the slope of the budget line. This is because, at the point of equilibrium, the consumer has optimally allocated their income between the goods to maximize their satisfaction. Any change in the allocation would lead to a lower level of satisfaction. The slope of the indifference curve represents the marginal rate of substitution (MRS) between the goods, which is the rate at which the consumer is willing to trade one good for another to maintain the same level of satisfaction. The slope of the budget line represents the relative prices of the goods. When these slopes are equal, the consumer is optimally allocating their income between the goods to achieve maximum satisfaction. Therefore, the correct answer is: A: Equal to the slope of the budget line

The correct answer is (c) Inelastic. The demand for necessaries, which are essential goods or basic needs, tends to be inelastic. Inelastic demand means that the quantity demanded does not significantly change in response to changes in price. Necessities are often items that consumers require regardless of price fluctuations, leading to a relatively stable demand even when prices change.

Cardinal Approach:

The cardinal approach, also known as the utility approach or the classical approach, is a method in economics that quantifies the satisfaction derived by consumers from consuming goods and services. This approach is based on the assumption that consumers can measure their preferences numerically in terms of "utils," a unit of measurement that represents the satisfaction gained from consuming a good or service.

Relation to the given options:

• Indifference curve: An indifference curve represents different combinations of goods that provide the same level of satisfaction to the consumer. The cardinal approach and indifference curve are related in the sense that both are used to analyze consumer preferences, but they are based on different assumptions. The cardinal approach assumes that utility can be measured numerically, while the indifference curve (ordinal approach) assumes that consumers can only rank their preferences.
• Equi-marginal utility: The equi-marginal utility principle states that consumers maximize their satisfaction by allocating their income in such a way that the last unit of money spent on each good yields the same marginal utility. This principle is directly related to the cardinal approach, as it is based on the idea of measurable utility and involves the comparison of marginal utilities to make consumption decisions.
• Law of diminishing returns: The law of diminishing returns states that as more units of a variable input are added to a fixed input, the marginal product of the variable input eventually decreases. While this concept is related to the overall idea of diminishing utility, it is not directly related to the cardinal approach, as it mainly deals with production and not consumer satisfaction.
• None of these: This option is incorrect, as the cardinal approach is directly related to the equi-marginal utility principle.

So, the correct answer is:

B:

Equi-marginal utility

Answer: A. Perfect complements Explanation: - Right-angled indifference curve: It is a type of indifference curve that forms a right angle or L-shape. This indicates that the consumer prefers consuming goods in fixed proportions, meaning the consumer will not substitute one good for another. - Perfect complements: These are goods that are consumed together in fixed proportions. The utility derived from one good directly depends on the consumption of the other good. Examples include left and right shoes, or a pen and ink. - Reason for the answer: In the case of a right-angled indifference curve, since the goods are consumed together in fixed proportions, they exhibit the characteristics of perfect complements. Other types of goods mentioned in the options: - Perfect substitutes: These are goods that can be completely substituted for each other without affecting the utility derived by the consumer. In this case, the indifference curve would be a straight line with a constant slope. - Inferior goods: These are goods for which demand decreases as a consumer's income increases. This has no direct relation to the shape of the indifference curve. - Giffen goods: These are a specific type of inferior goods, where demand increases as the price of the good increases. This is a rare phenomenon and also has no direct relation to the shape of the indifference curve.

Total utility is maximum when:

• Marginal utility is Zero

Explanation:

• Total utility refers to the total satisfaction or benefit derived from consuming a good or service.
• Marginal utility is the additional satisfaction or benefit gained from consuming one more unit of a good or service.
• As a consumer consumes more units of a good, the marginal utility of that good eventually decreases.
• This concept is known as the Law of Diminishing Marginal Utility.
• When the marginal utility of a good becomes zero, it means that consuming one more unit of the good will not provide any additional satisfaction or benefit to the consumer.
• At this point, the total utility derived from the good is at its maximum, as consuming more units will not increase the consumer's satisfaction.