Principles of Economics I-Microeconomics Lecture Notes PDF

ADVANCED DIPLOMA IN BUSINESS MANAGEMENT PRINCIPLES OF ECONOMICS I–MICROECONOMICS National Institute of Business Management  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T Session Seven Or...

ADVANCED DIPLOMA IN BUSINESS MANAGEMENT PRINCIPLES OF ECONOMICS I–MICROECONOMICS National Institute of Business Management  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T Session Seven Ordinal Utility Theory Limitation of Marginal Utility Analysis Marginal Utility Theory (Cardinal Utility approach) assumes that utility can be measured using Utils. But no one in the world has ever succeeded in defining utils. Hence it is difficult to accept utils as a universal measurement unit for utility. Indifference Curve  An indifference curve shows different combinations of two products that yield the same level of satisfaction. Any point on the curve gives the customer the same satisfaction. The only difference would be the combination of product X and product Y. Qy IC 0 Qx Characteristics of Indifference Curve  Negative slope  Convex to Origin  Indifference curves cannot intersect each other.  Indifference curves away from the origin represent higher level of satisfaction. Slope of the Indifference Curve  Slope of the indifference curve is known as marginal rate of substitution(MRS)  MRS shows the rate at which the consumer is willing to substitute one good for another.  MRSxy = MUx/MUy = ΔY/ΔX PAGE 01 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T Diminishing MRS  As we move along the indifference curve we could observe that MRS has a diminishing pattern.  It is because, as consumers buy more of product X relative to product Y, they willing to give up less of Product Y to get one more unit of product X. Qy 22 MRS = 7 15 MRS = 3 9 MRS = 0.8 5 IC 0 4 5 7 12 Qx Budget Line  Budget line shows different combinations of two products that a consumer can buy with a budget constraint.  I = Px.X + Py.Y o I = Consumers Income o Px = Price of X o Py = Price of Y o Qx = Quantity of X o Qy = Quantity of Y o PAGE 02 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T  Slope of the budget line is Px/Py.  Graph (Assume I = 100Rs.Px = 20 Rs. And Py= 10Rs.)  If the consumer buys only X, he can buy 5 units of X (100Rs./20 Rs.)  If the consumer buys only Y, he can buy 10 units of Y (100Rs./10 Rs.)  It can be shown in the budget line as follows. Qy 10 0 5 Qx Change in Budget Line with graphs The budget line could change due to change in prices of the products or change in Income. The change in income would shift the budget line and the change is price of the product would change the intercept only in the product where the price is changing. Following graphs would illustrate you on how the budget line would change for different scenarios. PAGE 03 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T  Increase in Consumers Income Qy BL 2 0 BL 1 Qx  Decrease in Consumer Income Qy 0 BL 2 BL 1 Qx PAGE 04 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T  An increase in the Price of X Qy 0 BL 2 BL 1 Qx  A decrease in the Price of Y BL 2 Qy BL 1 0 Qx PAGE 05 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T  A DVA N C E D D I P L O M A I N B U S I N E S S M A N AG E M E N T Consumer Equilibrium  Equilibrium is found at the point where the indifference curve is tangent to the Budget line.  At this point slope of the budget line equals the slope of the indifference curve.  Px/Py = MUx /MUy  Graph Qy E1 y1 IC 1 0 X1 BL 1 Qx PAGE 06 N AT I O N A L I N S T I T U T E O F B U S I N E S S M A N AG E M E N T