AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour

Students must practice these AP Inter 1st Year Economics Important Questions 2nd Lesson Theory of Consumers Behaviour to boost their exam preparation.

AP Inter 1st Year Economics Important Questions 2nd Lesson Theory of Consumers Behaviour

Long Answer Questions

Question 1.
Explain the law of diminishing marginal utility and its limitations.[Mar. ’19 (TS); May 2018: May, Mar. – 17]
Answer:
The law of diminishing marginal utility, an important law related to consumption, was introduced by H.H. Gossen in 1854.

Assumptions of the Law: The law is based on. the following assumptions.

  1. Utility is cardinal. It means that it i§ possible to measure the utility numerically in numbers like 14 utils, 7 utils, etc.
  2. The units of the good are homogenous in the sense that they are of the same quality, size, taste, etc.
  3. The units of the good are of reasonable size, neither too big nor too small.
  4. The consumer is rational and he always wants to maximise his utility.
  5. Utilities of goods are independent and they do not depend on other goods.
  6. There is no change in the tastes and preferences of the consumer.
  7. There is continuity and no time gap between the consumption of- different units of the good.
  8. The goods used by the consumer are not rare goods like old stamps, old coins, etc.
  9. The marginal utility of money remains constant.
  10. The goods used by the consumer are divisable.

Definition of the Law: “The additional- benefit which a person derives from a given increase of his stock a thing diminishes with every increase in the stock that he already has.” – Marshall.

“As a consumer increases the consumption of any one commodity, keeping constant the consumption of all the commodities, the marginal utility of the variable commodity must eventually decline.” – K.E. Boulding

The law explains the functional relationship between the stock of a good and its marginal utility. The law states that as we consume additional units of the same good continuously, the marginal utility of each such additional unit decreases.

The law can be explained with the help of the following table and diagram.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 1
From the above table, it is very clear that when the consumer eats apples continuously without any time gap, the first apple gives him 40 utils of satisfaction and its marginal utility is also 40 utils. The second apple gives an additional/marginal utility of 30 utils. The third apple gives him a marginal utility (additional utility) of 20 utils, the 4th apple (an additional) marginal utility of 10 utils. In other words, 4 apples or 4 units of X give the consumer total utility of 100 utils. Up to the 4th apple, there is an increase in total utility (at a decreasing rate) indicating a decrease in margined utility, with marginal utility being positive.

When the consumer eats (uses) the 5th apple, there is no further increase in total utility (total utility being maximum), with the corresponding marginal utility being 0. When the consumer eats the 6th apple, the total utility of 6 apples decreases to 90 utils indicating a marginal utility of – 10.

The above table indicates the following relationship between total utility and marginal utility.

  • When total utility increases at a diminishing rate, the marginal utility decreases, being positive.
  • When total utility is maximum, marginal utility is zero.
  • When total utility decreases, the corresponding marginal utility is zero.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 2

In the above diagram on Y axis total utility and marginal utility are shown and on X axis quantity or number of apples are shown. Up to the 4th apple, total utility has increased at a decreasing rate, reaching a maximum of 100 utils. Even with the use of 5th apple, total utility remained constant at 100 utils. With the use of 6th apple, total utility has decreased to 90 utils, with MU curve entering negative zone.

Limitations/Exceptions:
1. The law will not apply in the case of hobbies like collecting of old stamps, etc. In such cases, one gets more and more marginal utility with a collection of additional units.

2. The law does not apply in the case of money. The margined utility of money increases with the earning of each additional rupee.

3. The law will not apply in the case of drunkards and liquor. Drunkards get more and more kick as they drink additional pegs of wine.

4. The law does not apply in the case of indivisible goods.

5. The law does not apply in the case of misers. Misers get more and more happiness as they accumulate every additional rupee.

6. The law will not apply if there are any changes in the incomes, tastes and preferences
of the consumers.

7. The law does not apply in the case of reading. Reading of each additional book provides more and more knowledge.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour

Question 2.
Critically examine the law of equi-marginal utility.
Answer:
This law was introduced by H.H Gossen and is called Gossen’s second law. This is an important law, based on cardinal utility, which explains consumer equilibrium. It is also known as law of substitution, law of maximum satisfaction.

Assumptions of the Law:

  1. The consumer is rational and he tries to maximise his satisfaction (utility) with minimum money expenditure.
  2. Utility is cardinal utility, which: means utility is indicated in numbers or numerical terms.
  3. The marginal utility of money is constant.
  4. There is no change in the income of the consumer.
  5. The income of the consumer is constant and he spends all of his income on different goods.
  6. Prices of goods are given and they remain constant.
  7. Utilities of various goods are independent.
  8. Goods are divisible and can be substituted for each other.

Definition: “If a person has a thing which can be put to several uses’ he will distribute it among these uses in a such way that it has the same marginal utility in all.” – Alfred Marshall

Any rational consumer wants to get maximum satisfaction from every rupee he spends. If he finds that a rupee spent on product A gives more utility than on another product, namely product B, he substitutes product A (purchases more of A) for/ to product B (by purchasing less of B) until the marginal utilities of last units purchased of A and B are equal. Similarly, he also compares the marginal utility of any good purchased with the price paid to that good.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 3
The consumer is having an income of Rs. 20/ – which he wants to spend. The prices of good x is Rs. 3/- per unit and price of good y is Rs. 4/- per unit. In such a case, he purchases 4 units of good X (by spending Rs. 12/- on X Rs. 3 x 4) and 2 units of Y (by spending Rs. 8/-. on Y Rs. 4 x 2).

As per the above table when he purchases 4 units of X and 2 units of Y, the MU/P of last unit (4th unit) purchased of X is getting equal with MU/P of last unit (2nd unit) purchased of Y and reaches his equilibrium by getting maximum utility or satisfaction.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 4

In the above diagram, the marginal utility of AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 5 is shown through the line XX1 and the marginal utility of AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 6 is shown through the line YY1 When the consumer purchases OT quantity (4 units) of X, the marginal utility of the last unit of X (4th unit of X) is RT (in numerical terms 8). In the same way, when the consumer purchases OS quantity (2 units of Y) of Y, the marginal utility of last unit of Y (that is 2nd unit of Y) is PS (in numerical terms 8).

In the diagram, PS and RT are 2 parallel lines where PS (8) is equal to RT (8). So, a consumer reaches his equilibrium and gets maximum satisfaction when the marginal utilities of last units purchased of various goods are equal.

Criticisms (Limitations):

  • The law of equity-marginal utility is not applicable to indivisible goods and applies only to divisible goods.
  • The law assumes that the consumer is rational and tries to maximize his utility. But some of his purchases may not be rationally influenced by fashions, advertisements, etc.
  • The law is not applicable to complementary goods.
  • Certain important assumptions of the Jaw like cardinal measurability of utility, and constant marginal utility of money are not true and not realistic.
  • Fluctuations in the prices of goods, and consequent changes in the utilities of goods prevent the working of the law.
  • The law is not applicable to ignorant consumers, who are unaware of the market prices of the goods and their marginal utilities.

Question 3.
Explain the consumer’s equilibrium with the law of equi-marginal utility. [March 2018, May 2016]
Answer:
This law was introduced by H.H. Gossen and is called Gossen’s Second Law. This is an important law, based on cardinal utility, which explains consumer equilibrium. It is also known as law of substitution, law of maximum satisfaction.

Assumptions of the Law:

  1. The consumer is rational and he tries to maximize satisfaction (utility) with minimum money expenditure.
  2. Utility is cardinal utility, which means the utility is indicated in numbers or in numerical terms.
  3. Marginal utility of money is constant.
  4. There is no change in the income of the consumer.
  5. The income of the consumer is constant and he spends all of his income on different goods.
  6. Prices of goods are given and they remain constant.
  7. Utilities of various goods are independent.
  8. Goods are divisible and can be, substituted for each other.

Definition: “If a person has a thing which can be put to several uses, he will distribute it among these uses in a such way that it has the same marginal utility in all.” – Alfred Marshall

Any rational consumer wants to get maximum satisfaction from every rupee he spends. If he finds that a rupee spent on product A gives more utility than on another product, namely product B, he substitutes product A (purchases more of A) for/to product B (by purchasing less of B) until the marginal utilities of last units purchased of A and B are equal. Similarly, he also compares the marginal utility of any good purchased with the price paid to that good.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 7

The consumer is having an income of Rs. 20/ – which he wants to spend. The prices of good x is Rs. 3/- per unit and price of good y is Rs. 4/- per unit. In such a case, he purchases 4 units of good X (by spending Rs. 12/- on X. Rs. 3×4) and 2 units of Y (by spending Rs,. 8/- on Y Rs. 4 x 2). As per the above table when he purchases 4 units of X and 2 units of Y, the MU/P of last unit (4th unit) purchased of X is getting equal with MU/P of last unit (2nd unit) purchased of Y and reaches his equilibrium by getting maximum utility or satisfaction.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 8

In the above diagram, marginal utility of AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 5 is shown through the line XX1 and marginal utility of AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 6 is shown through the line YY1 When the consumer purchases OT quantity (4 units) of X, the marginal utility of last unit of X (4th unit of X) is RT (in numerical terms 8). In the same way, when the consumer purchases OS quantity (2 units of Y) of Y, the marginal utility of last unit of Y (that is 2nd unit of Y) is PS (in numerical terms 8).

In the diagram, PS and RT are 2 parallel lines where PS (8) is equal to RT (8). So, a consumer reaches his equilibrium and gets maximum satisfaction when the marginal utilities of last units purchased of various goods are equal.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour

Question 4.
Explain the consumer’s equilibrium using the indifference curve. [March. ’19 (AP)]
Answer:
Under indifference curve analysis, the equilibrium of the consumer can be explained with the help of an indifference map and price line/budget line.

Conditions of consumer equilibrium: Under the indifference technique, a consumer reaches his equilibrium, when the following two conditions are satisfied.

1. There should be tangency between price line and the indifference curve. In other words, the slope of the price line should be equal to the slope of the indifference curve (MRS AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 9

2. At the point of tangency where the slopes of the indifference curve and price line are equal, the indifference should be convex to the origin.

Explanation of consumer equilibrium: The following diagram explains consumer equilibrium.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 10

In the above diagram AB is the price line indicating an expenditure of Rs. 50. In the indifference map, there are 3 indifference curves IC1, IC2 and IC3.

At points P and Q, the Indifference curve is interesting the price line. At these points of intersection, the consumer gets lesser satisfaction with an expenditure of Rs. 50. But at point E, which is the point of tangency between price line and indifference curve 2, the consumer gets higher satisfaction/utility with the same expenditure of Rs. 50. So, P and Q the points of intersection between price line and indifference curve are not the points of consumer equilibrium. Only E, the point, of tangency between price line and indifference curve 2, is the point of consumer equilibrium.

At point E, (the point of tangency) IC2 is also convex to. the origin. So, the consumer, by spending Rs. 50, and purchasing OM of X and ON of Y is getting the maximum possible satisfaction indicated by indifference curve 2.

Question 5.
Define price line/budget line and explain shifts in the budget line.
Answer:
A budget line, also known as price line, shows different combinations (quantities) of two goods (X and Y or mangoes and oranges) that can be purchased by the consumer, with a given income (Rs. 50) and with the prices X (Mangoes) Rs. 10 and with the price of Y (oranges) Rs. 5. It is also known as ISO expenditure line. Any point on the same price line/budget line results in the same or equal expenditure to the consumer. It can be drawn by connecting or joining maximum quantities of X and Y.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 11

Shifts in budget line or price line take place with a change in the income of the consumer, with the price of X (mangoes) and Y (oranges) remaining constant.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 12

In the above diagram, PL is the original Price line/Budget line, showing an expenditure Rs. 150 and income of Rs. 150. When his income has increased to Rs. 200/- he would be able to spend to Rs. 200, and new price line has shifted to the right of the original, and it is P1L1 When there is a decrease in his income, he would be able to spend only Rs.100. The new price line has shifted to the left of the original one, and it is P2L2.

Short Answer Questions

Question 1.
Difference between Cardinal utility and Ordinal utility. [May 2018]
Answer:
1. Cardinal utility: The utility which can be quantified or expressed or measured in numerical terms is known as cardinal utility. It can be expressed in the form of utils. E.g: Utility of an apple is 14 utils and a banana is 7 utils.

2. Ordinal utility: The utility which is not quantifiable or which cannot be measured in numerical terms is known as ordinal utility.

Differences between Cardinal utility and Ordinal utility:

Cardinal Utility Ordinal Utility
1) It can be quantified or expressed or measured in numerical terms or numbers. 1) It cannot be expressed or measured in numbers or numerical terms.
2) Consumer can say very clearly how much more or how much less utility he gets from different goods. 2) Consumer cannot say how much or how much less he gets from different goods.

Question 2.
Properties of Indifference curve. [Mar. ’19 (TS); Mar. ’18; May, Mar. ’17; May ’16]
Answer:
An indifference curve, also known as ISO – utility curve, is a curve that consists of various points (combinations of two different goods Ex: X and Y or mangoes and oranges) which give the consumer the same or equal level of satisfaction. In other words, any point on the same in difference curve gives or provides the consumer the same or equal level of satisfaction.

Properties of Indifference curves:

  1. Indifference curves slope downwards from left to right. They have a negative slope.
  2. Indifference curves are convex to the origin.
  3. Two indifference curves cannot intersect each other.
  4. A higher indifference curve in an indifference map represents a higher level of satisfaction than a lower indifference curve.
  5. An indifference curve cannot touch either X – axis or Y – axis.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour

Question 3.
Marginal Rate of Substitution.
Answer:
An indifference curve, also known as Iso – Utility curve, is a curve that consists of various combinations (points) of two different goods which give the consumer, the same or equal level of satisfaction.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 13

An important basis of indifference curve is marginal rate of substitution. Marginal rate of substitution is such substitution of one good for another (two different goods) which results in or gives the same level of satisfaction to the consumer before substitution and after substitution.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 14

As the consumer moves from top to bottom on the Indifference, Marginal rate of substitution decreases indicating that Indifference curve slopes downward from left to right with negative slope.

Question 4.
Indifference Map.
Answer:
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 15
An indifference map is a set of two or more indifference curves which indicate different levels of satisfaction of the consumer. All the indifference curves in an indifference map are convex to the origin and are parallel to each other. In an indifference map, a higher indifference Curve indicates a higher level of satisfaction than a lower indifference curve.

Question 5.
Price Line. [March. ’19 (AP)]
Answer:
A price line, also known as a budget line, is a straight line that shows different combinations (quantities) of two different goods (E.g: X and Y or Mangoes and Oranges) that can be purchased by the consumer with a given income (Rs 50/-) and with the given prices X (Rs. 10/-) and Y (Rs 5/-). The price line is also known as Iso expenditure line.

A price line can be drawn by connecting the maximum quantities of two goods that can be purchased with the given income of the consumer and given prices of X and Y.

A higher price line indicates more expenditure to the consumer than a lower price line. Any point on the same price line/budget line results in the same or equal expenditure to the consumer.
AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour 16

Very Short Answer Questions

Question 1.
Utility.
Answer:
The term utility can be defined as the want satisfying power or capacity of a good or service. In Economics, satisfaction and welfare are also known as utility.

AP Inter 1st Year Economics Important Questions Chapter 2 Theory of Consumers Behaviour

Question 2.
Cardinal utility. [Mar. 19 (TS); May, Mar. 17]
Answer:
The utility which can be expressed or measured in numerical terms or in numbers is known as cardinal utility. E.g: Utility of good X is 14 utils and that of good Y is 7 utils. Since cardinal utility is measured in numbers, the consumer can say very clearly how much more and how much less utility he gets from different goods. .

Question 3.
Ordinal utility. [Mar. ’19 (AP)]
A. The utility which is not quantifiable or which cannot be measured or expressed in numerical terms is known as cardinal utility. The consumer can compare the ordinal utility of different goods but cannot say clearly how much more or how much less utility he gets from different goods.

Question 4.
Scale of preference.
Answer:
The term scale of preference refers to the pre-conceived opinions of the people towards various goods and their quality. People generally feel that apple is superior when compared to banana in terms of nutritional value. So people are prepared to pay a higher price to apples than bananas. They always prefer apple to banana.

Question 5.
Price line / Budget line. [May, Mar. ’18; May ’16]
Answer:
A price line, also known as a budget line, shows the different (quantities) combinations of two goods (namely X and Y or mangoes and oranges) that can be purchased by the consumer with a given income (Rs. 50/-) and with given prices of X (Rs. 10/-) and Y (Rs. 5/-). Price line is also known as the budget line or Iso expenditure line. Any point on the same price line/budget line results in the same or equal amount of expenditure to the consumer.

Question 6.
M.R.S. (Marginal Rate of Substitution)
Answer:
Marginal Rate of Substitution is such substitution of one good for another (two different goods) which results in or gives the same level of satisfaction to the consumer before substitution and after substitution.

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