CA – Foundation CA- Intermediate CA- Final

CA-FOUNDATION
CRASH COURSE MATERIAL

Business Economics
Chapter 2 – Demand, Supply & Consumer Behaviour

By Prof. Shashi Kiran.M

Advait Learning 9353164696 / 8660386382

www.advaitlearning.com
 Economics Chapter 2

Unit 1- Demand
Demand constitutes 3 important elements :
• Desire to buy
• Ability to pay
• Willingness to spend

Any commodity at a given point of time, for a given price if a customer is ready to purchase it
constitutes Demand.
Or
Desire Backed by a purchasing capacity with a willingness to spend.

Determinants of Demand:
Demand is influenced by lot of factors through which demand changes from time to time hence it is
referred as determinants.
1. Price:
PRICE is the most important determinant which influences demand to a maximum extent.
When Price Demand
Price Demand Main THUMB RULE of Demand Unit
i.e. Price is primary factor & Demand is secondary factor
or
Demand is dependent on price (When price changes Demand also changes)

The Relationship between price & demand is expressed in a mathematical equation known
as D= f(p)

Direct Indirect

D = Demand (Dependent factor)

P = Price (Independent factor)
f = functional relationship

Direct (+) relationship Indirect(-) relationship

When Price Demand When Price Demand
Price Demand Price Demand

2. Income
Income represents purchasing capacity.
When Y D
Y. D

3. TAX
When Tax rate increases, Demand decreases
DISPOSABLE PERSONAL INCOME (DPI)
DPI= Income – Tax

4. Climatic Condition (Summer, winter & rainy )

Depending upon Climatic condition demand for a particular commodity varies
Ex. CoCo Cola, Rain Coat, Clothing.

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 Economics Chapter 2

5. Advertisement
Advertisement is an one effective tool through which the information about a Good or
Services is passed, it creates an urgeness over consumers to purchase a product.

6. Taste & Preferences

Taste – It is an important factor which creates a repeated demand for a product if one
provides a desired taste to a consumer.
Ex- Hotels & chat shops.

Preference – Customs & usage of a person depending upon the needs.

Ex- Veg & Non-veg food.

7. Population
When the population of an nation is more even the demanding capacity will be more & vies-
versa, Demand can be based on Age group, class of society, religion, industry etc.

8. Complementary & Substitute goods

Complementary goods – are those goods which are consumed together.
Ex: Bike & petrol
Note : “Complementary goods are always negatively/ Indirectly related”. HOW????
If Price of PETROL Demand for BIKE & vice-versa.

Substitute goods – are those goods which are next best alternative goods.
Ex: Coffee & tea (or) Diary milk & Gon mad/kit-kat/perk
Note : “Substitute goods are always positively/ directly related”. HOW????
Assuming price of COFFEE & TEA both are Rs.10/-
when price of coffee increases to Rs.12/- & Tea price still remains Rs.10/-
Automatically people shifts from COFFEE to TEA due to increase in price of COFFEE.

Hence, When PRICE of Coffee DEMAND for Tea & vice-versa.

There are still many more factors which influences the demand but these 8 determinants are
important.

SHORT CUT to remember determinants of demand - PIT CAT PC’s

P- Price,
I- Income,
T- Tax,
C- Climatic Condition,
A- Advertisement,
T- Taste & Preferences,
P- Population
C’s – Complementary & Substitute goods

Law of Demand
According to Ceteris Paribus, All things remains constant when price demand
when price demand ( Indirect/ Negative relationship)

i.e. in PIT CAT PC’s only the first P- Price is variable factor & all others IT CAT PC’s are fixed
factors (Only PRICE changes due to which DEMAND also changes)

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 Economics Chapter 2

“Law of Demand tell us only a direction of Change, So it is called as Qualitative statement”.

It fails to tell us, How much more the customer is going to buy when price (or) how much
less the customer is going to buy when price .

Exception to LAW OF DEMAND ( Direct/Positive relationship)

1. Conspicuous consumption
It refers to a prestigious/ Luxury goods, where consumer measures the utility of a
commodity by its price, i.e. if the commodity is expensive they think it has got more
utility.
Ex: Gold/Diamonds , even if Price people still demands those prestigious goods, they
don’t decrease purchasing of it.

2. Giffen goods
Are those goods which are inferior (low quality) in nature on which customers spends
major part of their income.
Ex: PUMA & POMA (or) Normal Rice & Biryani rice.

3. Conspicuous necessaries (Demonstration/ Band wagon effect)

Are those goods for which demand is determined by usage of others.
Ex: cloths , cell phone etc.

4. Expectation of future change in price

Ex: Festivals , Share market etc.

5. Emergencies
Ex: Food articles in highway, Virus out break , natural destructions etc.

6. Speculation activity
Ex: Auction sale , Betting , Gambling etc.

7. Basic Necessities for life.

Ex: Cooking gas, food etc.

8. Trends & Changes (Torn jeans)

Demand Schedule & Demand Curve

Demand Schedule- Representing Demand in a form of a table.

Price Total Demand Batman Superman Ironman

10 55 22 15 18
8 65 27 18 20
6 75 30 20 25
4 85 32 25 28
2 95 35 28 32

When, Price Demand

Price Demand

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 Economics Chapter 2

Types of Demand Schedule :

• Individual demand schedule : It represents demand created by an individual
customer with relation to change in price.
• Market demand schedule : It represents demand created by all the customers in a
market with relation to change in price.

Demand Curve- Representing demand schedule in a form of graph is known as demand

curve .

Types of Demand curve : Individual & Market demand curve.

Y
D

P1
Price (Rs.)

O X
Q Q1

Quantity (units)

P & Q represents original Price & Quantity

P1 & Q1 is a change in price & Quantity
D represents Demand curve

When, P1 D(Q1)

“Demand Curve is downward sloping curve from left to right”(Negative slope). WHY????
• LDMU – Law of diminishing marginal utility
• Substitution effect
• New Consumer
• Alternative/ Multiple uses

Elasticity of Demand
It is a responsiveness or change in quantity demanded due to change in some determinants
of demand.
Some determinants are ( Types of Elasticity of demand )
1. Price Elasticity of demand (PeD)
2. Income Elasticity of demand (IeD)
3. Cross Elasticity of Demand (CeD)
4. Advertisement Elasticity of demand (AeD)

“Elasticity of Demand not only tell us a direction of Change it also tell us how much
quantity/ numerical change in form of percentage, So it is also called as Quantative
statement”.

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 Economics Chapter 2

EoD= % in ‘Q’ Demanded

% in Price

Difference between Law of Demand & Elasticity of Demand

Law of Demand Elasticity of Demand

It only represents direction of change in It represents Numerical/ percentage change
price & quantity along with direction of change in price &
quantity
It is Qualitative statement It is Quantitive Statement

• PRICE ELASTICITY OF DEMAND

It is a responsiveness or change in quantity demanded due to change in price of a
commodity.

EoD= % in ‘Q’ Demanded

% in Price

Types of price elasticity Numerical value Nature of demand curve

Relatively elastic e>1 Flatter demand curve
Relatively in-elastic e<1 Steeper demand curve
Unitary elastic e=1 Downwards sloping demand curve
Perfectly in-elastic. e=0 Vertical demand curve or Parallel to ‘Y’ axis
Perfectly elastic. e= ¥ Horizontal demand curve or Parallel to ‘X’ axis

RELATIVELY ELASTICITY OF DEMAND

A small change in price leads to a large change in quantity demanded. (e>1)

P1 D

P ΔP

ΔQ

O Q1 Q

P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
10 100 101 X 6012 12 1.2
15 160 10010 51 10

Conclusion : If price increases by 1% , Quantity demanded decreases by 1.2% & vice- versa

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RELATIVELY IN-ELASTICITY OF DEMAND

A Large change in price leads to a small change in quantity demanded. (e<1)

P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
10 100 101 X 204 04 0.4
5 120 10010 51 10

Conclusion : If price increases by 1% , Quantity demanded decreases by 0.4% & vice- versa

UNITARY ELASTICITY OF DEMAND

Whatever will be the change in price, Quantity demanded will also change in same proportion. (e=1)

P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
10 100 101 X 5010 10 1
5 150 10010 51 10

Conclusion : If price increases by 1% , Quantity demanded decreases by same 1 % & vice- versa

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 Economics Chapter 2

PERFECTLY IN-ELASTICITY OF DEMAND

Whatever may be the change in price, Quantity demanded remains unchanged. (e=0)

P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
10 100 101 X 00 00 0
5 100 10010 05 10

Conclusion : If price changes by 1% , Quantity demanded decreases by 0 %

PERFECTLY ELASTICITY OF DEMAND (Unrealistic/ myth )

Whatever may be the change in price, Quantity demanded cannot be determined. (e=¥)

Measurements of Price Elasticity of Demand

1. Formula Method :

Already done

2. ARC Method
It was developed to overcome the problems of Formula method.

Solve the below mentioned two problems to understand the disadvantage of Formula
method.

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Problem 1-
P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
10 100 101 X 306 06 0.6
15 70 10010 051 10

Conclusion: As the outcome of a problem is 0.6 i.e. e<1 , It is Relatively In-elastic.

Problem 2-
P = Previous price
Q = Previous Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
15 70 153 X 30 90 1.29
10 100 70 051 70

Conclusion: As the outcome of a problem is 1.29 i.e. e>1 , It is Relatively Elastic.

Observation:
Problem 1 is reversed and made it as Problem 2 but the outcome of both the problems are
different ( Problem 1 is Relatively In-elastic & Problem 2 is Relatively Elastic).
In mathematics even if problem is reversed the outcome of a problem should be same.

Formula method is not so appropriate & it contains disadvantage as above stated with
example, Hence ARC Method was introduced.

ARC Method Formula

P1+ P2 = Previous price + New price

Q 1+Q2 = Previous Quantity + New Quantity
ΔP = Difference between old & new Price
ΔQ= Difference between old & new Quantity

Price Quantity
15 70 30 X (15+10) 30 X 255 15 0.89
10 100 05 (70+100) 051 170 17

Conclusion: The outcome of a problem is 0.89 i.e. e<1 , It is Relatively In-elastic.

Note: In an exam if a numerical problem is given without specifying which method to be use
(Formula or ARC), Use Formula method initially you will get an answer which matches with
given 4 option,

Suppose if you cannot find the answer in any off the 4 options given, then try ARC method.
Most of the problems will be in Formula method

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3. Point Method (Unrealistic/ Myth)

It is used to find those changes which is extremely small.

Lower Segmention the demand curve( LS )

EP =
Upper Segment on the demand curve (US )

Space between A,B,C,D & E is Considered as Segments.

i.e. Space between A & B is one segment,
Space between A to E has 4 segments.
AE 04
A= ¥ E=¥
0 0
BE 3
B= 3 E>1
BA 1
CE 2
C= 1 E=1
CA 2
DE 1
D= 0.3 E<1
DA 3
0 0
E= 0 E=0
EA 4

4. Total Outlay method

As a result of change in price, Whether customer is going to spend more or less is what we
are interested.
We are considering spending capacity of a consume due to change in price.

Person Price Quantity Outlay (P*Q) PeD Conclusion

6 * 10 60 Due to change in price, spending
Batman 5 * 15 75 E>1 nature of Batman is increasing.
4 * 20 80

6 * 10 60 Even though there is change in

Superman 5 * 12 60 E=1 price, Superman is spending
4 * 15 60 same amount of money.

6 * 10 60 Due to change in price, spending

Iron man 5 * 11 55 E<1 nature of Iron man is decreasing.
4 * 13 52

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 Economics Chapter 2

• INCOME ELASTICITY OF DEMAND

It is change in demand due to change in income of a consumer.

IoD= % in Demand
% in Income

Engel’s Curve: It is a relationship between Income of a consumer & Quantity demanded of a

particular commodity.

If, e>1 Luxury goods

e<1 Necessaries/ Normal good
e=1 luxury/ Necessary goods
e=0 No change in quantity, irrespective
of change in Income

Measurements of Income Elasticity of Demand

1. Formula method

2. ARC Method

Note:

Normal Goods Inferior Goods

When, Price Demand When, Price Demand
Price Price Demand Price Demand
(Negative relationship) (Positive relationship)
When, Income Demand When, Income Demand
Income Income Demand Income Demand
(Positive relationship) (Negative relationship)

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 Economics Chapter 2

• CROSS ELASTICITY DEMAND

It is a responsiveness or change in quantity demanded of ‘Good A’ due to change in price of
‘Good B’.
It holds good for Complementary & Substitute goods.
Complementary goods – are those goods which are consumed together.
Ex: Bike & petrol
Note : “Complementary goods are always negatively/ Indirectly related”. HOW????
If Price of PETROL Demand for BIKE & vice-versa.

Substitute goods – are those goods which are next best alternative goods.
Ex: Coffee & tea (or) Diary milk & Gon mad/kit-kat/perk
Note : “Substitute goods are always positively/ directly related”. HOW????
Assuming price of COFFEE & TEA both are Rs.10/-
when price of coffee increases to Rs.12/- & Tea price still remains Rs.10/-
Automatically people shifts from COFFEE to TEA due to increase in price of COFFEE.

Hence, When PRICE of Coffee DEMAND for Tea & vice-versa.

Ce D= % in Quantity Demanded of ‘Good A’

% in Price of ‘Good B’

Problem 1 :
Miss. Anushka own a coffee shop where she sells 100 coffees per day for Rs.10/- each, due
to increase in price of raw materials she increased coffee price to Rs.12/- due to which her
sales reduced to 75 coffees per day, An opposite tea shop of Mr.Kholi stated receiving more
customers all off a sudden in a recent time where he sells Tea for Rs.10/-each & sales per
day increased from 400 cups of tea to 500 cups of tea. Calculate Cross elasticity of demand?

Problem 2:
If Price of INK went up by 25%, Quantity demanded of PEN went down by 20%. Calculate
CeD?

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 Economics Chapter 2

• ADVERTISEMENT ELASTICITY OF DEMAND

It is a responsiveness or change in demand due to change in spending’s on advertisement.

Ae D= % in Quantity Demanded .
% in Price of spending’s on Advt

Expansion or Contraction of Demand curve

• It is a change in Demand only due to change in PRICE.
i.e. in PIT CAT PC’S , only P- Price is going to change a demand
• It is movement on same Demand curve
• When, Price Demand Contracts
Price Demand Expands

Increase or Decrese of Demand curve

• Increase or Decrease in demand is due to change in other factors except PRICE.
i.e. in PIT CAT PC’S , only P- Price is going to constant, IT CAP PC’s will change a
demand.
• It is Shift in Demand curve.
• If other factor except price demand curve will shift RHS
If other factor except price demand curve will shift LHS

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A) Increase in demand

B) Decrease in demand

Note : AR curve is also called as Demand curve.

Demand is a flow concept.
Demand unit is from consumers point of view

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 Economics Chapter 2

Unit- 2 SUPPLY
Supply is a part of stock which is offered for sale, Supply is a flow concept.
Supply is from Manufacturer point of view.

Determinants of Supply:
Supply is influenced by lot of factors through which supply changes from time to time hence it is
referred as determinants.

1. Price
When, Price Supply
Price Supply

2. Price of related goods

3. Technology
4. Factors of Production
5. Govt policies

Law of Supply
All things remains constant, When price supply , when price supply

The Relationship between price & supply is expressed in a mathematical equation known as S= f(p)
It is known as supply function.

Supply Schedule & Supply Curve

Supply Schedule- Representing Supply in a form of a table.

Price Total Supply Apple OPPO MI

100 1000 500 300 200
150 1200 550 400 250
170 1350 590 450 310
200 1500 650 500 350
250 1850 750 600 500

When, Price Supply

Price Supply

Types of Supply Schedule :

• Individual supply schedule : It represents supply created by an individual customer
with relation to change in price.
• Market supply schedule : It represents supply created by all the customers in a
market with relation to change in price.

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 Economics Chapter 2

Supply Curve- Representing Supply schedule in a form of graph is known as Supply curve .
Types of Supply curve: Individual supply curve & Market supply curve.

Elasticity of Supply
It is a responsiveness or change in quantity supplied due to change in price.
EoS= % in ‘Q’ Supplied
% in Price

Types of supply Numerical Nature of supply curve Extended supply

elasticity value curve cuts
Relatively elastic e>1 Flatter supply curve ‘Y’ Axis
Relatively in-elastic e<1 Steeper supply curve ‘X’ Axis
Unitary elastic e=1 Up-wards sloping supply Intersects at
curve Origin
Perfectly in-elastic. e=0 Vertical supply curve or
Parallel to ‘Y’ axis
Perfectly elastic. e= ¥ Horizontal supply curve
or Parallel to ‘X’ axis

RELATIVELY ELASTICITY OF SUPPLY

A small change in price leads to a large change in quantity supplied. (e>1)

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 Economics Chapter 2

RELATIVELY IN- ELASTICITY OF SUPPLY

A large change in price leads to a small change in quantity supplied. (e<1)

UNITARY ELASTICITY OF SUPPLY

Whatever will be the change in price, Quantity supplied will also change in same proportion. (e=1)

PERFECTLY IN-ELASTICITY OF SUPPLY

Whatever may be the change in price, Quantity supplied remains unchanged. (e=0)

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 Economics Chapter 2

PERFECTLY ELASTICITY OF SUPPLY (Unrealistic/ myth )

Whatever may be the change in price, Quantity supplied cannot be determined. (e=¥)

Measurements of Elasticity of Supply

1. Formula Method :

2. ARC Method
It was developed to overcome the problems of Formula method.

3. Point method
4. Total outlay method

Note: Measurements is already discussed in Demand & it remains same in supply also.

Expansion or Contraction of Supply curve

• It is a change in Supply it is only due to change in PRICE.
• It is movement on same Supply curve
• When, Price Supply Expands
Price Supply Contracts

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 Economics Chapter 2

Increase or Decrease of Supply curve

• Increase or Decrease in Supply is due to change in other factors except PRICE.
• It is Shift in Supply curve.
• If other factor except price Supply curve will shift RHS
If other factor except price Supply curve will shift LHS

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 Economics Chapter 2

Unit 3- Consumer Behaviour

Fundamental premise of economics is we assume every consumer is Rational Consumer.

Rational consumer- Whose choice is consist with goals, by a limited resources a consumer tries to
satisfy their unlimited wants.

This unit explains us at what point a consumer will be satisfied a most.

A particular point/position where consumer is able to satisfy as many wants as possible with the
given resources, it is said by EQUILIBRIUM.

Max Satisfaction
EQUILIBRIUM
No change

When the above two conditions are satisfied, a consumer is set be in equilibrium.

v Who are we going to achieve Equilibrium??

There are two different methods which tells us how to achieve equilibrium.
1. CARDINAL APPROACH
2. ORDINAL APPROACH

CARDINAL APPROACH
• It was developed by Prof.Alfrad Marshal.
• This theory is based on one important principle which states “Cardinal measurability of Utility is
possible” i.e. satisfaction can be measured in terms of numbers (Utils)
UTILITY – It is a want satisfying capacity of a commodity.
UTILS – It is a tool to measure Utility/satisfaction.
• Under this approach we study
i. LDMU- Law of diminishing marginal utility
ii. Consumer surplus theory

ORDINAL APPROACH
• It was developed by R.J.D Allen & J.R. Hicks.
• Due to the drawbacks of Cardinal approach & to accept in practical ORDINAL APPROACH was
developed.
• It is not possible to measure satisfaction in terms on number, instead we can arrange satisfaction
in an order of PREFERENCES/ RANKS.
• Under this approach we study
i. Indifference curve
ii. Budget line

Basic concepts
1. Total Utility (TU)
It is a summation/Cumulative of all the utilities derived from a given set of units.

TU= U1+U2+U3+U4+…………………Un
Ex: Mr. A purchases a pack of ORIO Biscuits which had 10biscuits in it & consumed all 10
biscuits one by one.

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Cardinal approach says satisfaction can be measured in terms of numbers/utils.

Mr.A after consuming a 1st biscuit got 10 utils of satisfaction
Mr.A after consuming a 2nd biscuit got 30 utils of satisfaction
Mr.A after consuming a 3rd biscuit got 60 utils of satisfaction
Mr.A after consuming a 4th biscuit got 100 utils of satisfaction
Mr.A after consuming a 5th biscuit got 150 utils of satisfaction
Mr.A after consuming all first 10 biscuits he has got 300 utils of satisfaction

It means Total Utility (TU) of 2nd Biscuits is 10+25 (1st + 2nd biscuit put together) i.e.30Utils
TU of 3rd Biscuit is 10+20+30 (1st + 2nd + 3rd biscuits put together) i.e. 60Utils

Note : “TU is Cumulative in nature”.

2. Average Utility (AU)

It is a Utility derived by one single unit of output.
AU= TU/Q

Lets continue a same above example of Mr.A

Units TU AU AU=TU/Q (Calculation)

1 10 10 10/1
2 30 15 30/2
3 60 20 60/3
4 100 25 100/4
5 150 30 150/5

3. Marginal Utility (MU)

It is a utility derived by one additional/ one extra unit of output.

MU=TUn - TUn-1 (when output is continuous )

MU= DTU/DQ (when output is not-continuous)

Problem 1: when output is continues

Units TU AU MU MU = TUn-TUn-1
1 10 10 10 As MU speaks only about one unit
2 30 15 20 MU=TU2-TU1 i.e. MU= 30 - 10
3 60 20 30 MU=TU3-TU2 i.e. MU= 60 - 30
4 100 25 40 MU=TU4-TU3 i.e. MU= 100 - 60
5 150 30 50 MU=TU5-TU4 i.e. MU= 150 - 100

Problem 2: when output is not-continues

Units TU MU MU= DTU/DQ (D = present – previous)
0 0 0 When Output is 0 even TU,AU & MU will be zero
2 20 10 (DTU = 20 – 0 = 20) (DQ= 2 – 0 = 2) MU= 20/2= 10
4 80 30 (DTU = 80 –20 = 60) (DQ= 4 – 2 = 2) MU= 60/2= 30
6 160 40 (DTU = 160 –80 = 80) (DQ= 6 – 4 = 2) MU= 80/2= 40
8 260 50 (DTU = 260 –160 = 100) (DQ= 8 – 6 = 2) MU= 100/2= 50
10 380 60 (DTU = 380 –260 = 120) (DQ= 10 – 8 = 2) MU= 120/2= 60

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 Economics Chapter 2

Law of Diminishing marginal utility

A additional benefit a consumer derives from a given increase in stock of anything, diminishes with
the stock he already has.
If a consumer goes on consuming a particular commodity, satisfaction that he gets from a
commodity diminishes.

Assumptions of LDMU
1. Should be a rational consumer (Choice are consistent with goals)
2. Continues consumption (without time gap)
3. Homogeneous goods and services (Identical)
4. Commodity should be provided for free of cost
5. Cardinal measurability of utility is possible

Units TU MU
1 50 50
2 75 25
3 95 20
4 110 15
5 120 10
6 120 0
7 100 -10

Limitations of LDMU
1. Rare Collections
2. Money
3. Harmful drugs

Consumer surplus theory

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Whatever extra worth of satisfaction that consumer enjoys is known as Consumer surplus.
Consumer surplus = Potential price – Actual price
CS=PP-AP

Potential Price : Price which customer is ready to pay

Actual price : Price which we pay

The concept of Consumer surplus is subject to LDMU i.e. the price which we are ready to pay (PP)will
reduce gradually when we go on consuming a particular commodity.

Ex: movie ticket

Units PP or MU AP CS
1 20 10 10
2 15 10 05
3 10 10 00
Total 45 30 15

PP is also known as MU
When P=MU i.e. in Unit 3 a consumer is in equilibrium
In CS customer is going to pay a price for a commodity

The Shaded region represents Consumer surplus, hence it is also called as WELFARE TRIANGLE

Area of Triangle = ½ x b x h
= ½ x 3 units x (20-10)
= ½ x 3 x 10
= ½ x 30
= 15

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Equilibrium condition
• In case of single commodity P=MU
• In case of two commodities
"#$ "#&
%$ = %&

• In case of more then two commodity

"#$ "#& "#'

%$
= %&
……………. %'

Indifference curve
All those combination of two commodities which gives same level of satisfaction, if they are
connected in a form a curve is called IC Curve.

Assumptions
• Having limited Income
• He/she completely buy’s two commodities
• Later it will be barter system

Features of IC Curve
1. IC Curve always slops down wards from Left to Right (Due to limited Income)

2. Always CONVEX to origin

Due to diminishing Rate of Substitution (ROS)
ROS- It is a rate at which one commodity is exchange with another

Rate of Substitution is always diminishing in nature hence IC curve is also known as “Law of
diminishing rate of substitution”.

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 Economics Chapter 2

Combination Tea Biscuits ROS

A 1 12
1:4
B 2 8
C 3 5 1:3
D 4 3 1:2
E 5 2 1:1

To increase the consumption of one commodity, need to sacrifice the consumption of other
commodity

Exception to rule Convex

In case of PERFECT SUBSTITUTE
Y

3
2
1
IC
0 1 2 3 X

In Case of PERFECT COMPLEMENTARY

Y

IC
O X

3. IC Curve which is away from the origin or RHS has Higher level of satisfaction

If there is more than one IC cure in a graph, we call it as Indifference map.

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 Economics Chapter 2

4. No IC Cure will intersect with each other,

5. IC Curve need not be parallel to each other i.e. It may or may not be parallel to each other

6. No IC Curve will touch any of its axis

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Budget line
All those combination of two commodities that consumer can buy at a given Income & Price level.
It is also called as Price line or Income line.

Ex: Assuming Mr.Shashi has Rs.60 & he has to purchase commodity A & B with the existing money.
Commodity A costs Rs.10 each.
Commodity B costs Rs.15 each.

As per above mentioned income & price level, Max of 6 units of product A & 4 units of product B can
be purchased. (Black line in a below mentioned graph)

Situation 1: When Income of a consumer has increased & price of a product remains same.
Income Rs.75/-
Commodity A costs Rs.10 each.
Commodity B costs Rs.15 each.
As per above situation 1, with a given income & price level, Max of 7.5 units of product A &
5 units of product B can be purchased. Budget line shifts RHS

Situation 2: When Income of a consumer is constant &price of a product has increased.

Income Rs.60/-
Commodity A costs Rs.12 each.
Commodity B costs Rs.20 each.
As per above situation 2, with a given income & price level, Max of 5 units of product A &
3 units of product B can be purchased. Budget line shifts LHS

Note: Reason for RHS & LHS in Budget line.

Right hand side shift (RHS) – Due to Increase in income or Decrease in price of a product.
Left hand side shift (LHS) – Due to decrease in income or Increase in price of a product.

Prof. Shashi kiran. M Page 27

 Economics Chapter 2

Condition for Equilibrium under Ordinal approach

1. BUDGET LINE should be tangent to IC curve.
2. At the point of tangency, MRS/ROS should be equal.

Prof. Shashi kiran. M Page 28