Consumption and Demand
Multiple Choice Questions (MCQs)
1.Which concept explains the satisfaction a consumer derives from consuming a good or service?
a) Utility
b) Demand
c) Consumption
d) Equilibrium
Correct Answer: a) Utility
2.According to the Law of Diminishing Marginal Utility, as a consumer consumes more units of a good, the marginal utility from each successive unit:
a) Increases
b) Decreases
c) Remains constant
d) Becomes negative initially then positive
Correct Answer: b) Decreases
3.Total utility is maximized when marginal utility is:
a) Increasing
b) Decreasing
c) Zero
d) Negative
Correct Answer: c) Zero
4.The Law of Equimarginal Utility states that a consumer achieves equilibrium when the ratio of marginal utility to price is equal for all goods consumed. This implies:
a)
fracMU_AP_A
fracMU_BP_B
b) $\frac{MU\_A}{P\_A} \< \frac{MU\_B}{P\_B}$
c)
$fracMU_AP_A=$
$fracMU_BP_B=MU_M (Marginal Utility of Money)$
d) MU_A=MU_B
Correct Answer: c)
$fracMU_AP_A=$
$fracMU_BP_B=MU_M (Marginal Utility of Money)$
5.When the market demand for a product is derived, it is typically by:
a) Summing up the quantities demanded by all individual consumers at each price.
b) Averaging the quantity demanded by individual consumers.
c) Summing up the prices paid by all consumers.
d) Calculating the product of individual demands.
Correct Answer: a) Summing up the quantities demanded by all individual consumers at each price.
6.Which of the following is a determinant of demand?
a) Cost of production
b) Technology
c) Price of related goods
d) Availability of raw materials
Correct Answer: c) Price of related goods
7.A table showing the quantities of a good that an individual consumer is willing and able to buy at different prices during a specific period is called a:
a) Demand curve
b) Supply schedule
c) Individual demand schedule
d) Market demand curve
Correct Answer: c) Individual demand schedule
8.A "movement along the demand curve" is caused by a change in:
a) Income of the consumer
b) Price of the good itself
c) Tastes and preferences
d) Price of substitute goods
Correct Answer: b) Price of the good itself
9.If the price of coffee increases, the demand for tea (a substitute good) will likely:
a) Decrease
b) Remain unchanged
c) Increase
d) Become elastic
Correct Answer: c) Increase
10.Which of the following would cause a "shift to the right" of the demand curve for cars?
a) An increase in the price of petrol
b) A decrease in consumer income
c) An increase in consumer preferences for cars
d) An increase in the price of cars
Correct Answer: c) An increase in consumer preferences for cars
11.Price elasticity of demand measures the responsiveness of quantity demanded to a change in:
a) Consumer income
b) Price of related goods
c) Price of the good itself
d) Tastes and preferences
Correct Answer: c) Price of the good itself
12.If the price elasticity of demand for a good is greater than 1 (E_d1), demand is considered:
a) Inelastic
b) Unitary elastic
c) Elastic
d) Perfectly inelastic
Correct Answer: c) Elastic
13.When the total expenditure on a good remains constant despite a change in its price, the price elasticity of demand is:
a) E_d1
b) $E\_d \< 1$
c) E_d=0
d) E_d=1
Correct Answer: d) E_d=1 (Unitary Elastic)
14.For a perfectly inelastic demand curve, the value of price elasticity of demand is:
a) Zero
b) One
c) Infinite
d) Greater than one
Correct Answer: a) Zero
15.Which of the following goods is likely to have a more elastic demand?
a) Salt
b) Life-saving medicine
c) Luxury car
d) Rice
Correct Answer: c) Luxury car
16.If a 10% increase in the price of a good leads to a 5% decrease in its quantity demanded, the demand is:
a) Elastic
b) Inelastic
c) Unitary elastic
d) Perfectly elastic
Correct Answer: b) Inelastic (E_d=0.5)
17.What is the relationship between price elasticity of demand and total expenditure when demand is elastic (E_d1)?
a) Price and total expenditure move in the same direction.
b) Price and total expenditure move in opposite directions.
c) Total expenditure remains constant.
d) There is no definite relationship.
Correct Answer: b) Price and total expenditure move in opposite directions.
18.If a good is a necessity, its price elasticity of demand is likely to be:
a) Elastic
b) Inelastic
c) Unitary elastic
d) Perfectly elastic
Correct Answer: b) Inelastic
19.The geometric method for measuring price elasticity of demand on a linear demand curve uses the formula:
a)
$fractextUppersegmenttextLowersegment$
b)
$fractextLowersegmenttextUppersegment$
c)
$fractextChangeinQtextChangeinP$
d)
$fractextPercentagechangeinQtextPercentagechangeinP$
Correct Answer: b)
fractextLowersegmenttextUppersegment
20.Which of the following is NOT a determinant of price elasticity of demand?
a) Nature of the commodity (necessity vs. luxury)
b) Availability of substitutes
c) Time period
d) Cost of production
Correct Answer: d) Cost of production
Short Questions
1.Define utility.
Answer: Utility refers to the satisfaction, pleasure, or benefit that a consumer expects to derive from consuming a good or service. It is a subjective concept, varying from person to person.
2.State the Law of Diminishing Marginal Utility.
Answer: The Law of Diminishing Marginal Utility states that as a consumer consumes more and more units of a specific commodity, the utility or satisfaction derived from each successive unit consumed tends to decrease, assuming other factors remain constant.
3.What is the consumer's equilibrium condition using the cardinal utility approach for a single commodity?
Answer: For a single commodity, a consumer is in equilibrium when the marginal utility of the good (MUx) divided by its price (Px) is equal to the marginal utility of money (MUM). That is,
fracMU_xP_x=MU_M.
4.Define demand in economics.
Answer: In economics, demand refers to the quantity of a good or service that consumers are willing and able to purchase at various possible prices during a specific period, assuming other factors remain constant.
5.Distinguish between individual demand and market demand.
Answer: Individual demand refers to the quantity of a good that a single consumer is willing and able to buy at different prices. Market demand is the sum of all individual demands for a particular good at each possible price in the market during a specific period.
6.List any three determinants of demand (other than the price of the good itself).
Answer: Three determinants of demand are:
Income of the consumer
Price of related goods (substitutes and complements)
Tastes and preferences of the consumer
7.What is a demand schedule?
Answer: A demand schedule is a tabular statement that shows the different quantities of a commodity that consumers are willing and able to buy at different possible prices during a given period, assuming other determinants of demand are constant.
8.Explain the difference between 'movement along the demand curve' and 'shift in the demand curve'.
Answer: A 'movement along the demand curve' occurs when the quantity demanded changes solely due to a change in the price of the good itself. A 'shift in the demand curve' occurs when the quantity demanded changes due to a change in any non-price determinant of demand (like income, tastes, price of related goods), causing the entire curve to move either left or right.
9.Define price elasticity of demand.
Answer: Price elasticity of demand (E_d) measures the responsiveness (or sensitivity) of the quantity demanded of a good to a change in its own price, all other factors remaining constant.
10.What does it mean for demand to be perfectly inelastic? Give an example.
Answer: Perfectly inelastic demand means that the quantity demanded does not change at all, regardless of any change in price. The price elasticity of demand is zero (E_d=0). An example is life-saving medicine for a critical patient where no substitutes exist.
11.If the price elasticity of demand is 0.5, is demand elastic or inelastic? Interpret your answer.
Answer: If E_d=0.5, demand is inelastic. This means that a given percentage change in price leads to a proportionately smaller percentage change in quantity demanded. For example, a 10% increase in price would cause only a 5% decrease in quantity demanded.
12 State the formula for calculating price elasticity of demand using the percentage method.
Answer: The formula for price elasticity of demand using the percentage method is:
E_d=
fractextPercentagechangeinQuantityDemandedtextPercentagechangeinPrice
13.When demand is elastic (E_d1), what is the relationship between a change in price and total expenditure?
Answer: When demand is elastic, price and total expenditure move in opposite directions. If the price decreases, total expenditure increases; if the price increases, total expenditure decreases.
14.Why do luxury goods tend to have more elastic demand than necessities?
Answer: Luxury goods tend to have more elastic demand because they are not essential for survival. Consumers can easily postpone their purchase or go without them if their prices increase significantly, making their demand highly responsive to price changes. Necessities, on the other hand, are essential, so demand does not change much with price.
15.What is the significance of the Law of Equimarginal Utility for a consumer?
Answer: The Law of Equimarginal Utility helps a rational consumer achieve maximum satisfaction (equilibrium) when allocating their limited income among various goods. It ensures that the last rupee spent on each commodity yields the same marginal utility, maximizing total utility from their expenditure.
Long Questions (5 Marks each)
1.Explain the concepts of Total Utility and Marginal Utility. Illustrate the Law of Diminishing Marginal Utility with a hypothetical numerical example and a diagram. Also, discuss how Total Utility changes as Marginal Utility decreases.
Answer:
Total Utility (TU): Total utility refers to the total satisfaction or pleasure derived by a consumer from consuming all units of a commodity within a given period. It is the sum of marginal utilities obtained from each successive unit consumed.
Marginal Utility (MU): Marginal utility refers to the additional utility or satisfaction derived from consuming one more unit of a commodity. It is the change in total utility resulting from consuming one additional unit of a good.
MU_n=TU_n−TU_n−1
Law of Diminishing Marginal Utility (LDMU):
The Law of Diminishing Marginal Utility states that as a consumer consumes more and more units of a specific commodity, the marginal utility derived from each successive unit tends to decrease, assuming all other factors remain constant (ceteris paribus). This law is fundamental to understanding consumer behavior and the downward sloping demand curve.
Hypothetical Numerical Example:
Let's consider the consumption of oranges by a consumer.
Units of Oranges Consumed (Q)
Total Utility (TU)
Marginal Utility (MU) (TU_n−TU_n−1)
|
Units of Oranges Consumed (Q) |
Total Utility (TU) |
Marginal Utility (MU) (TU_n−TU_n−1) |
|
1 |
10 |
10 |
|
2 |
18 |
8 |
|
3 |
24 |
6 |
|
4 |
28 |
4 |
|
5 |
30 |
2 |
|
6 |
30 |
0 |
|
7 |
28 |
-2 |
Explanation of Example:
From the 1st orange, the consumer gets 10 units of satisfaction (MU=10, TU=10).
The 2nd orange gives 8 units of additional satisfaction (MU=8), making total utility 18.
As more oranges are consumed, the marginal utility consistently decreases (10, 8, 6, 4, 2...). This illustrates the Law of Diminishing Marginal Utility.
When the 6th orange is consumed, MU becomes zero (MU=0), meaning the consumer has reached saturation, and total utility is maximized (TU=30).
Consuming the 7th orange yields negative marginal utility (MU=-2), indicating dissatisfaction, and total utility starts to decline (TU=28).
Diagram:
(Imagine a graph with Units of Oranges on the X-axis and Utility on the Y-axis. There would be two curves: a TU curve and an MU curve.)
Total Utility Curve (TU): Starts from the origin, increases at a decreasing rate, reaches a maximum point (when MU is zero), and then starts to decline.
Marginal Utility Curve (MU): Slopes downwards, intersecting the X-axis when TU is maximum, and then becomes negative.
Utility
^
| TU (increases at a decreasing rate, peaks, then declines)
| / \
| / \
| / \
| / \
+-----------+------> Units of Oranges
| \
| \
| \
|MU (slopes downwards, crosses X-axis when TU is max, then negative)
|
|
v
Relationship between Total Utility and Marginal Utility:
When MU is positive and decreasing: TU increases, but at a decreasing rate. (Units 1 to 5 in the example)
When MU is zero: TU is at its maximum point. This is the point of saturation. (Unit 6 in the example)
When MU is negative: TU starts to decrease. This indicates over-consumption and dissatisfaction. (Unit 7 in the example)
This relationship shows that as consumers consume more of a good, they eventually reach a point where additional units provide less and less satisfaction, ultimately leading to a decline in total satisfaction if consumption continues beyond the point of zero marginal utility.
2.Explain the meaning of 'Demand' and its key determinants. Illustrate the difference between 'movement along the demand curve' and 'shift in the demand curve' with suitable diagrams and examples.
Answer:
Meaning of Demand:
In economics, demand refers to the quantity of a specific good or service that consumers are both willing and able to purchase at various possible prices during a given period of time, assuming all other factors remain constant (ceteris paribus). It is important to note that demand is not just about desire; it must be backed by purchasing power.
Key Determinants of Demand (other than the price of the good itself):
These factors cause a shift in the demand curve.
Price of Related Goods:
Substitute Goods: Goods that can be used in place of each other (e.g., tea and coffee). If the price of a substitute good increases, the demand for the original good will increase (demand curve shifts right).
Complementary Goods: Goods that are consumed together (e.g., cars and petrol). If the price of a complementary good increases, the demand for the original good will decrease (demand curve shifts left).
Income of the Consumer:
Normal Goods: For most goods, an increase in consumer income leads to an increase in demand (demand curve shifts right).
Inferior Goods: For some goods (e.g., low-quality grains, used clothes), an increase in consumer income leads to a decrease in demand (demand curve shifts left) as consumers switch to higher-quality alternatives.
Tastes and Preferences: Changes in consumer tastes or preferences towards a good can increase or decrease its demand. Favorable changes shift the demand curve right, unfavorable changes shift it left.
Expectations about Future Prices: If consumers expect the price of a good to rise in the future, they might increase their current demand (shift right). If they expect prices to fall, they might postpone purchases, decreasing current demand (shift left).
Population Size and Composition: An increase in the total population or a change in its demographic structure (e.g., more young people) can lead to a change in market demand.
Distribution of Income: A more equitable distribution of income can increase the demand for mass consumption goods.
Movement Along the Demand Curve vs. Shift in the Demand Curve:
1. Movement Along the Demand Curve (Change in Quantity Demanded):
Cause: A movement along the demand curve occurs only when there is a change in the price of the good itself, while all other determinants of demand remain constant.
Effect: It leads to either an expansion of demand (price falls, quantity demanded increases) or a contraction of demand (price rises, quantity demanded decreases).
Diagram: The consumer moves from one point to another on the same demand curve.
Price
^
| D
| /
P1----A----
| /|
| / |
P2--B-+----
| / |
+---+--+-----> Quantity Demanded
Q1 Q2
Example: If the price of apples falls from P1 to P2, the quantity demanded increases from Q1 to Q2, resulting in a movement from point A to point B along the same demand curve D.
2. Shift in the Demand Curve (Change in Demand):
Cause: A shift in the demand curve occurs when there is a change in any of the non-price determinants of demand (e.g., income, tastes, price of related goods), while the price of the good itself remains constant.
Effect: It leads to either an increase in demand (demand curve shifts right) or a decrease in demand (demand curve shifts left).
Diagram: The entire demand curve moves to a new position.
Price
^
|
| D1 D2 (Shift to the right - Increase in Demand)
| / /
P----X----Y----
| / /
| / /
+---------+-----> Quantity Demanded
Q1 Q2
Example (Shift to the Right/Increase in Demand): If consumer income increases, people might demand more of a normal good (e.g., cars) even at the same price (P). The demand curve shifts from D1 to D2, and quantity demanded at price P increases from Q1 to Q2.
(A shift to the left/Decrease in Demand would occur if a non-price factor, like a decrease in income for a normal good, causes a reduction in demand at every price level.)
In summary, a "movement" is along the curve due to price changes, while a "shift" is of the entire curve due to non-price factors.
3.Define Price Elasticity of Demand. Explain its determinants in detail. Also, explain the relationship between price elasticity of demand and total expenditure with relevant examples.
Answer:
Price Elasticity of Demand (E_d):
Price elasticity of demand is a measure of the responsiveness (or sensitivity) of the quantity demanded of a good to a change in its own price, assuming all other factors remain constant. It tells us the percentage change in quantity demanded for a one percent change in price.
Formula: E_d=
fractextPercentagechangeinQuantityDemandedtextPercentagechangeinPrice
Determinants of Price Elasticity of Demand:
Nature of the Commodity:
Necessities (e.g., salt, basic food grains, essential medicines): Have inelastic demand ($E\_d \< 1$). Even if prices change significantly, consumers will still buy roughly the same amount as they are essential for survival.
Luxuries (e.g., sports cars, designer clothing, expensive vacations): Have elastic demand (E_d1). Consumers can easily postpone their purchase or go without them if prices increase, making their demand highly responsive to price changes.
Comforts (e.g., fan, refrigerator): Fall between necessities and luxuries, often having moderately elastic demand.
Availability of Substitutes:
Many Close Substitutes (e.g., different brands of soft drinks, various types of cereals): Demand is likely to be elastic. If the price of one good rises, consumers can easily switch to its cheaper substitutes.
Few or No Close Substitutes (e.g., tap water, certain patented drugs): Demand is likely to be inelastic. Consumers have few alternatives, so quantity demanded won't change much with price.
Proportion of Income Spent on the Commodity:
Small Proportion (e.g., matchbox, salt): Demand tends to be inelastic. A price change has a negligible impact on the consumer's budget, so demand is not very sensitive.
Large Proportion (e.g., car, house, consumer electronics): Demand tends to be elastic. A change in price significantly affects the consumer's budget, leading to a greater responsiveness in quantity demanded.
Time Period:
Short Period: Demand tends to be inelastic. Consumers have limited time to adjust their consumption patterns, find substitutes, or change habits.
Long Period: Demand tends to be elastic. Given more time, consumers can explore and switch to substitutes, adjust their behavior, or adopt new technologies, making their demand more responsive to price changes.
Number of Uses of a Commodity:
Multiple Uses (e.g., electricity, milk): Demand tends to be elastic. If the price increases, its use might be restricted to more essential purposes, leading to a significant drop in overall demand.
Single Use (e.g., cooking oil in a specific recipe): Demand tends to be inelastic.
Addictive or Habitual Goods: Goods like cigarettes or certain medications for addicts often have inelastic demand because consumers are less responsive to price changes due to habit or addiction.
Relationship between Price Elasticity of Demand and Total Expenditure:
The Total Expenditure Method (or Total Outlay Method) establishes a relationship between changes in the price of a good and the total amount of money spent by consumers on that good.
Let Total Expenditure (TE) = Price (P)
times Quantity Demanded (Q)
Elastic Demand (E_d1):
Relationship: Price and Total Expenditure move in opposite directions.
Explanation: When demand is elastic, a percentage change in price leads to a proportionately larger percentage change in quantity demanded.
If Price Falls: Quantity demanded increases significantly, leading to an increase in Total Expenditure.
If Price Rises: Quantity demanded decreases significantly, leading to a decrease in Total Expenditure.
Example: If the price of a luxury car falls by 10%, and demand is elastic (E_d=1.5), quantity demanded might rise by 15%, increasing the total revenue for the car manufacturer.
Inelastic Demand ($E\_d \< 1$):
Relationship: Price and Total Expenditure move in the same direction.
Explanation: When demand is inelastic, a percentage change in price leads to a proportionately smaller percentage change in quantity demanded.
If Price Falls: Quantity demanded increases only slightly, leading to a decrease in Total Expenditure.
If Price Rises: Quantity demanded decreases only slightly, leading to an increase in Total Expenditure.
Example: If the price of salt increases by 20%, and demand is inelastic (E_d=0.2), quantity demanded might fall by only 4%, leading to an increase in total expenditure on salt for consumers.
Unitary Elastic Demand (E_d=1):
Relationship: Total Expenditure remains constant regardless of the change in price.
Explanation: When demand is unitary elastic, a percentage change in price leads to an exactly equal percentage change in quantity demanded in the opposite direction.
If Price Falls: Quantity demanded increases by an equal percentage, and Total Expenditure remains the same.
If Price Rises: Quantity demanded decreases by an equal percentage, and Total Expenditure remains the same.
Example: If the price of a specific branded soap falls by 5%, and its demand is unitary elastic (E_d=1), the quantity demanded will increase by exactly 5%, resulting in no change in the total amount spent on that soap.
Understanding this relationship is crucial for businesses in making pricing decisions and for governments in formulating tax policies, as it helps predict the impact of price changes on revenue.
