1. Demand can be perfectly elastic or inelastic.Discuss.
2. Discuss 3 main properties of indifference curves(15marks)
b) Describe marginal rate of substitution.
1. Demand can be perfectly elastic or inelastic depending on the responsiveness of quantity demanded to changes in price.
a) Perfectly elastic demand refers to a situation where a very small change in price leads to an infinite change in quantity demanded. In this case, consumers are extremely sensitive to price changes, and any increase in price would cause a complete loss of demand. This occurs when there are many substitutes available for a product, the product represents a small portion of consumers' budgets, or there are low switching costs between different products.
b) Perfectly inelastic demand occurs when the quantity demanded remains constant regardless of changes in price. In this case, consumers are not responsive to price changes, and the demand curve is vertical. This typically happens when the product has no close substitutes, is a necessity, or when consumers have limited alternatives.
The concept of elasticity helps us understand how changes in price affect consumer behavior and market outcomes. Elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price.
To determine whether demand is elastic or inelastic, you need to calculate the price elasticity of demand using the following formula:
Elasticity of demand = (Percentage change in quantity demanded / Percentage change in price)
If the elasticity of demand is greater than 1, demand is considered elastic, indicating that consumers are highly responsive to price changes. If the elasticity of demand is equal to 1, demand is unitary elastic, meaning that the percentage change in quantity demanded is equal to the percentage change in price. If the elasticity of demand is less than 1, demand is considered inelastic, showing that consumers are not very responsive to price changes.
2. The three main properties of indifference curves are as follows:
a) Indifference curves are downward sloping: Indifference curves depict combinations of two goods that yield the same level of satisfaction. The downward slope of indifference curves reflects the principle of diminishing marginal utility. As an individual consumes more of one good while keeping the consumption of the other good constant, the additional utility gained from each successive unit of the good declines, leading to a trade-off between the two goods.
b) Indifference curves do not intersect: Indifference curves are distinct from one another and do not cross. This implies that each curve represents a unique level of satisfaction, and a higher curve represents a higher level of satisfaction. If two indifference curves were to intersect, it would imply that the consumer prefers a combination of goods that yields the same level of satisfaction as another combination, which contradicts the assumptions of rational choice.
c) Indifference curves are normally convex: Indifference curves exhibit a convex shape. This reflects the concept of diminishing marginal rate of substitution. As a consumer moves along the indifference curve, trading off one good for another, the rate at which they are willing to substitute decreases. This convexity indicates that consumers generally prefer a balanced combination of goods, rather than extreme quantities of one good and none of the other.
b) The Marginal Rate of Substitution (MRS) measures the rate at which a consumer is willing to give up one good in exchange for an additional unit of another good while maintaining the same level of satisfaction. It represents the slope of the indifference curve at a specific point.
The MRS is defined as the negative ratio of the change in the quantity of one good over the change in the quantity of the other good:
MRS = ΔQuantity of Good A / ΔQuantity of Good B
The MRS also indicates the rate at which a consumer is willing to trade one good for another to maintain the same level of utility. If the MRS is high, it means that the consumer is willing to give up a relatively large amount of one good to obtain an additional unit of the other good. Conversely, if the MRS is low, the consumer is only willing to give up a small amount of one good to obtain an additional unit of the other good.
The MRS can be derived from the slope of the indifference curve, which represents the trade-off between the two goods. Generally, the MRS decreases as the consumer moves along the indifference curve due to diminishing marginal rate of substitution.