Most Important Economics Q & A

ECONOMICS QUESTION AND ANSWERS ASKED DURING INTERVIEW and Examination OF IAS, IRS, IFS, IES, IBPS, UPSC and State departments.

(Part II)

Question : What is Utillity?

Answer :The term utility refers to the want satisfying power of a commodity.

Question : How to measure Utility?

Answer : Utility is a cardinal concept i.e., it can be measured.

Benham formulated the unit utils (i.e., say consumption of 2 units of X gives 10 utils).

According to Marshall “money should be used to measure utility”

(i.e., say consumption of 2 units of X give utility worth Rs.10).

Question : What is Total Utility?

Answer : It is the sum of all the utilities that a consumer derives from the consumption of a certain amount of a commodity. TUn= MU1 + MU2+….+MUn

Question : What is Marginal Utility (MU)?

Answer :

It is addition made to the total utility.

As consumption is increased by one more unit of the commodity.

MUn=TUn – TUn-1

Question : What is the relationship between TU and MU Curves?

Answer:

  • TU curve starts from the origin, increase at a decreasing rate, reaches a maximum and then starts falling.
  • MU curve is the slope of the TU curve, since MU =∆TUx/∆Qx
  • When TU is maximum, MU is zero, it is called saturation point. (since slope of TU curve at that point is zero). Units of the good are consumed till the saturation point.
  • As long as TU curve is concave, MU curve is downward sloping and remains above the x-axis.
  • When TU curve is falling, MU curve becomes negative.
  • The falling MU curve shows the law of diminishing marginal utility.
Relationship between TU and MU
Relationship between TU and MU
Question : Define  Law of Diminishing Marginal Utility (LDMU)

Answer :The law states that as a consumer consumes more and more units of a commodity, marginal utility derived from each successive unit goes on diminishing.

Question : Explain assumptions of the LDMU

Answer:

Measurement unit is standard.

If the unit of measurement is very large or small then the law will not hold. Examples of inappropriate units are: rice measured in grammes, water in drops, diamonds in kilograms.

Homogeneous commodity. All units of the commodity consumed are homogeneous and perfect substitutes.

Continuous consumption. The law of DMU holds only when consumption of successive units of a commodity is without a time gap.

Mental and social condition of the consumer must be normal. The law will hold when consumer’s mental condition is normal. Income and tastes were unchanged. His behavior is rational.

Questions : Explain Assumptions of the Utility Approach

Answer :

Utility can be measured and It can be expressed in exact units. Utility is measurable in monetary terms.

Consumer’s income is given.

Prices of commodities are given and remain constant.

Constant Marginal Utility of Money. It means that importance of money remains unchanged.

Question : Define Law of Equi-Marginal Utility (LEMU).

Answer :

Consumer will allocate his expenditure in such a ways that, utility gained from the last rupee spent on each commodity is equal.

Law of Equi marginal Utility
Law of Equi marginal Utility

Question : Define Indifference Curve

Answer : An indifference curve shows different combinations of two goods that yield the same level of utility or satisfaction to the consumer.

indifference curve
indifference curve

Question : Mention Assumptions of the Indifference Curve Approach

Answer :

Rationality of a consumer

Ordinality : Utility is an ordinal concept. Consumer can order or rank the subjective utilities derived from the commodities.

Diminishing Marginal Rate of Substitution :

It is the amount of good Y the consumer is willing to give up to consume an additional unit of good X, while leaving total utility unchanged.

Consistency of Choice. Consumer is consistent in his choice.

Transitivity of Choice : A>B & B>C then A>C. Preference approach.

Monotonic Preference

Question : What is Indifference Schedule

Answer : It is a tabular presentation of various combinations of two goods that yield the same level of satisfaction to the consumer.

indifference Schedule
Indifference Schedule

Question : What is Indifference Map

Answer : A family of indifference curves is called an Indifference Map.

Indifference Map
Indifference Map

Question : Mention Properties of Indifference Curve

Answer :

1.      Downward sloping to the right

2.      Convex to origin

3.      Two curves do not intersect each other

4.      A higher indifference curve represents a higher level of satisfaction.

Question : Why two indifference curves never intersect?

Two indifference curves do not intersect each other. If they intersect, say, at point B then we get contradictory results in terms of preference ranking. In points A and B lie on the same indifference curve I1. So, the consumer must be indifferent between them. By the same logic consumer must be indifferent between points B and C lying on I2, by assumption of transitivity, consumer must be indifferent between point A and C. On Comparing points A and C, C is better than A as it has more units of good Y. Contradictory result appear. It implies indifference curves cannot intersect each other.

Indifference curve never intersect
Indifference curve never intersect

Answer :

Question : What is Marginal Rate of Substitution?

Answer : The slope of an indifference curve is called Marginal Rate of Substitution of X for Y, symbolically denoted as MRS. It is defined as the amount of Y that a consumer is willing to substitute for an additional unit of X.

Marginal rate of substitution
Marginal rate of substitution
Marginal rate of substitution
Marginal rate of substitution

Question : Budget line or income line

Answer : A budget line is a line which shows all possible combinations of two goods that a consumer can buy with his given income and prices of the commodities.

Question : Marginal rate of Exchange (Slope of Budget line).

Answer : Slope of the budget line measures the amount of change in good Y required per unit change in good X along the budget line. Slope of budget line is also called Marginal rate of exchange (MRE).

budget line, income line
Budget line

Question : Assumptions of Budget Line.

Answer : 

1. Income of consumer is given and remains unchanged.  

2. Commodities prices are given and remain unchanged.

Question : Shifts in Budget Line.

1.      Change in Income

2. Change in prices of commodities

3.    Simultaneous Change in Price of both commodities.

Question : How to find consumer equilibrium in indifference map?

Answer :

Its point must lie on the budget line and must give the most preferred combination of goods and services.  

Two conditions:

1. First equilibrium condition is necessary but it is not sufficient condition.

2. Second equilibrium stability condition, When Diminishing MRS is observed . It means, for a stable equilibrium, MRS must be continuously falling. This condition means that the indifference curve is strictly convex.

Consumer equilibrium in indifference curve
Consumer equilibrium in indifference curve

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