BUSINESS ECONOMICS

JUNE 2022

QUESTION 1

Assume that a consumer consumes two commodities X and Y and makes five combinations
for the two commodities:

Combination Units of X Units of Y

A 25 3
B 20 5
C 16 10
D 13 18
E 11 28

Calculate Marginal rate of Substitution and explain the answer.

ANSWER1:

FORMULA: MRS= -(ΔX/ΔY)

The table below shows the ΔX and ΔY and the Marginal rate of substitution calculated from
the formula above.

Combination X ΔX Y ΔY MRSxy = -
ΔY/ΔX
A 25 - 3 - -
B 20 -5 5 2 0.4
C 16 -4 10 5 1.25
D 13 -3 18 8 2.67
E 11 -2 28 10 5

Explanation:
Marginal rate of substitution - It implies that to increase quantity of one good an individual
has to let go off some units of another good. In the above example in order to increase units
of good Y, some units of good X are to be given up. MRS= -| ∆Y/ ∆X |. However, MRS
increases at diminishing rate i.e., less and less unit of X will be given up to procure more and
more units of Y.
 • The marginal rate of substitution is the willingness of a consumer to replace one
good for another good, as long as the new good is equally satisfying.
• The marginal rate of substitution is the slope of the indifference curve at any given
point along the curve and displays a frontier of utility for each combination of "good
X" and "good Y."
• When the law of diminishing MRS is in effect, the MRS forms a downward, negative
sloping, convex curve showing more consumption of one good in place of another.

For example, a consumer must choose between hamburgers and hot dogs. To
determine the marginal rate of substitution, the consumer is asked what
combinations of hamburgers and hot dogs provide the same level of satisfaction.

CORRECT ANSWER:

MRSxy (ΔX/ΔY) for the given data = A - -, B - 2.5, C - 0.8, D - 0.375, E - 0.2
QUESTION 2

Elaborate the term Total Revenue and Marginal revenue also calculate TR and MR in the
given table

Price Output (In Units) Total revenue Marginal

revenue
20 1

18 2

16 3

14 4

12 5

ANSWER:

TOTAL REVENUE:
The total revenue is the total amount a vendor can collect from the sale of
commodities or services to the customer. The price of the commodities can be
expressed as P × Q, which means the cost price of the commodities multiplied by the
amount sold. Therefore, total revenue (TR) is defined as the market cost price of the
commodity (P) multiplied by the enterprise's output (Q).
Thus,

TR = P X Q
Where
TR-Total Revenue,
P-Price,
Q-Quantity.

MARGINAL REVENUE:
Marginal revenue is the increase in revenue obtained from the sale of one additional unit of
product.

It is also defined as the revenue earned from the sale of a new product or unit. In
other words, it is the revenue that a company generates when it sells an extra
unit. Management uses it to analyse customer demands, plan the production
schedules, and set the prices of products.
In accordance with the law of diminishing returns, the margin of revenue remains
constant to a certain output level, and slows down as output increases.

MR = Change in total revenue(TR) /Change in quantity(Q)

Where

MR-Marginal Revenue,

TR-Total Revenue,

Q-Quantity.
The table below shows the total revenue and marginal revenue calculated from the formula
above

Price Output (In Total revenue Marginal

Units) revenue
20 1 20 20
18 2 36 16
16 3 48 12

14 4 56 8
12 5 60 4

QUESTION 3

3.A. From the given Demand Schedule for air tickets, calculate elasticity of demand.
 Price of Air Ticket (Per Quantity Demanded(Ticket
Ticket) per month)
100000 5000

120000 3500

3.B. Elaborate the term Elasticity of Supply and explain any three factors that determines
elasticity of supply

ANSWER 3A

FORMULA:

ELASTICITY OF DEMAND: A change in the price of a commodity affects its demand. We can find
the elasticity of demand, or the degree of responsiveness of demand by comparing the percentage
price changes with the quantities demanded.

We know from the formula of elasticity of demand that it is calculated by dividing the change
in the quantity of demand by the change in the price of demanded goods.
OR
Price Elasticity of Demand is the percentage of change in quantity demanded divided by the
percentage change in price

Price elasticity of Demand =- % change in Qd/ % change in P

Procedure / Steps:

We know from the formula of elasticity of demand that it is calculated by dividing the change
in the quantity of demand by the change in the price of demanded goods.
Therefore, the elasticity of demand = (120000 - 100000) / (5000 - 3500)
The elasticity of demand = 20000 / 1500
The elasticity of demand = 13.33
The elasticity of demand is positive which concludes that with the increase in price, the
demand for the quantity of air ticket decrease.
Hence, the elasticity of demand is 13.33.
Correct answer:
Hence, the elasticity of demand is 13.33.

ANSWER 3B.

Introduction:

The price elasticity of supply is a measure of the degree of responsiveness

of the quantity supplied to the change in the price of a given commodity. It
is an important parameter in determining how the supply of a particular
product is affected by fluctuations in its market price. It also gives an idea
about the profit that could be made by selling that product at its price
difference. In this article, we will discuss the elasticity of the supply
formula, different types of elasticity of supply, the supply curve
characteristics, and many more.

Concept and application:

Price Elasticity of Supply: The price elasticity of supply refers to the response to
a change in a good or service's price by the supply of that good or service.
According to basic economic theory, the supply of goods decreases when
its price increases.

Similarly, one can also study the price elasticity of demand. This illustrates how easily the
demand for a product can change based on changes in price. Price changes fairly rapidly if the
price of a product changes. This is known as price elasticity of demand.

Price Elasticity of Supply Formula

After having understood the elasticity of supply definition in economics, we now move to the
elasticity of supply formula which is based on its definition.

ES=%Δ/%ΔQ

Here,
ES denotes the elasticity of supply which is equal to the percentage change in quantity
supplied divided by the percentage change in the price of the commodity.
The Law of Supply:
Since producers compete for profits in a free market, profits are never constant over time or
across different goods. Entrepreneurs, therefore, shift resources and labour efforts towards
products that are more profitable and away from those that are less profitable.
The law of supply refers to the tendency for price and quantity to be related. For instance,
assume that consumers demand more oranges and fewer apples. More dollars are bidding for
oranges, but fewer for apples, resulting in higher orange prices.

Determinants of Price Elasticity of Supply

• Marginal Cost- As the cost of producing one more unit is rising with output or
Marginal Costs (which are the increased costs related to each additional unit produced)
are rising rapidly with output, then the rate of output production will be limited, i.e.
Price Elasticity of Supply will be inelastic., which means that the percentage of quantity
supplied changes less than the change in price. However, if Marginal Cost rises slowly,
then Supply will be elastic.
• Time- As the price elasticity of supply increases over time, producers would increase
the quantity supplied by a greater percentage than the price increases.
• Number of Firms- It is more likely that the supply will be elastic when there are a
large number of firms. This occurs because other firms can step in to fill the supply gap.
• Mobility of Factors of Production- When the factors of production are mobile, then
the price elasticities of supply are higher. This means that labour and other
manufacturing inputs may be imported from other regions to quickly increase
production.

Conclusion:

Supply elasticity is a measure of the responsiveness of an industry or a producer to changes in

demand for its product. The availability of critical resources, technology innovation, and the
number of competitors producing a product or service also are factors.