O and A Levels
Economics
CHAPTER 1
CONSUMER EQUILIBRIUM
Budget Line, Indifference Curve, Utility and Price Effect
Budget
Line
It is a line that depicts graphical representation of all possible combinations of two goods which can be purchased with
given income and prices, such that the cost of each of these combinations is equal to the money income of the consumer
Indifference Curve
A curve on a graph (the axes of which represent quantities of two commodities) linking those combinations of quantities
which the consumer regards as of equal value
**The Consumer is willing to consume at highest Indifference Curve i.e. IC2, But the budget line allows the consumer
to only consume at IC1 & IC3. Where the maximum level of satisfaction gained in given budget is were IC is tangent to
Budget line (Red dot).
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps
O and A Levels
Economics
PRACTICE QUESTIONS.
Utility
It is the satisfaction gained from consumption of a certain good commodity
or service. Its unit of measure is “util”
Assumptions
1. Consumer’s satisfaction can be quantified
2. Consumers are rational wanting to maximize satisfaction
3. The consumption is continuous
4. Each unit of the good is the same
Total Utility
The total utility (TU) is defined as the sum of the satisfaction that a person
can receive from the consumption of all units of a specific product or service
Marginal utility
Marginal utility (MU) is defined as the additional (cardinal) utility gained from
the consumption of one additional unit of a good or service or the additional
(ordinal) use that a person has for an additional unit.
The Law of Diminishing Marginal Utility
It states that all else equal as consumption increases the marginal utility
derived from each additional unit declines. Marginal utility is derived as the
change in utility as an additional unit is consumed
Relationship between Marginal Utility and Total Utility
When MU is Positive Total Utility is rising
When MU is Zero
Total Utility is at Maximum point
When MU is Negative Total Utility is at falling
**Consumer is at equilibrium where MU is equal to Price charged.
The Law of Equi-Marginal Utility
Consumer is in equilibrium position when marginal
utility of money expenditure on each goods is the
same.
MU of A = MU of B .
Price of A
Price of B
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps
O and A Levels
Economics
Price Effect
Price effect= Substitution Effect + Income Effect
The effect on the quantity demanded of a change in its own price is called the price effect. This shows the total effect of
price change. Change in price, in general, exerts two influences on quantity demanded
Substation Effect
The substitution effect is the change in consumption patterns due to a change in the relative prices of goods, holding the
real income constant. (Being at same indifference curve with tangent to budget line)
For example, when the price of a good falls (Commodity A), it becomes cheaper relative to other goods (Commodity B) in
the market. As a result, consumers switch away from the other good (Commodity B) towards the good (Commodity A).
**Relative price is the comparative price of the existing combination of two goods at an existing budget line.
Income Effect
The income effect is the change in consumption patterns due to a change in purchasing power (due to a fall in the price
of commodity A).
**It will be positive when a consumer purchases more of a commodity following a rise in real income
**It will be negative when a consumer purchases less of a commodity following a rise in real income
Substitution effect
A1 to A2
Income effect
A2 to A3
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps
O and A Levels
Economics
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps
O and A Levels
Economics
Price Effect for Different Types of goods
NORMAL GOODS
INFERIOR GOODS
GIFFEN GOODS
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps
O and A Levels
Economics
Talha Bhatti, Member-Institute of Public Accountants of Australia
Associate Member- Institute of Financial Accountants of UK
CAF- Institute of Chartered Accountants of Pakistan
M.Sc. (Lahore School of Accountancy and Finance- University of Lahore)
University of Punjab, B.A Economics
Lectured at: Bilim Institute, Beaconhouse BGTL, American Lyceum TSB, Lahore Learning Campus, IVY Preps