Economics: Indifference Curve, Marginal Rate of Substitution, Budget Constraints, Diminishing Marginal Utility, Income and Substitution Effects, Behavioural Economics

Running Head: Economics
Economics

Economics
Contents
Answer 1.......................................................................................................................... 2
a. Consumer’s Indifference Curve..................................................................................... 2
b. Marginal Rate of Substitution....................................................................................... 3
c. Consumer’s Budget Constraints..................................................................................... 4
d. Diminishing Marginal Utility........................................................................................ 5
e. Income and Substitution Effects.................................................................................... 6
Answer 2.......................................................................................................................... 7
Behavioural Economics..................................................................................................... 7
Critical Evaluation of the Reasons behind Consumers’ Irrational Behaviours...................................8
References...................................................................................................................... 10
1

Economics
Answer 1.
a. Consumer’s Indifference Curve
It shows all the possible combinations of two goods with which the consumers get equal amount of
satisfaction. Since, the points on the consumer’s indifference curve reflects the combinations of
two goods that yield equal satisfaction for the consumers, they act indifferently to the combinations
received by them in real (Britannica, n.d.).The higher indifference curve would give higher level of
satisfaction to the consumer and vice-versa.
Example:
TABLE 1: Combinations of Apple and Banana
APPLE BANANAS
22 17
14 20
10 26
9 41
7 80
Figure 1: Consumer’s Indifference Curve
Source: Economicshelp, 2016)
2

Economics
The consumer’s indifference curve in figure 1 shows the different combinations of Apple and
Banana that yields the same level of utility for the consumers that is, 22 Apples and 17 Bananas
would give the same satisfaction to consumer as 9 Apples and 41 Bananas. Therefore, indifference
curve is mostly negatively sloped, could never intersect at any point and are always convex to the
point of origin.
b. Marginal Rate of Substitution
The marginal rate of substitution is the rate at which the consumers are ready to give up some
amount of one product in exchange of another product as long as the same level of utility or
satisfaction is provided by the new product (The Economy, 2015). Each point on the curve shows
the quantities of product A and product B that consumers are ready to substitute for one another.
This concept of MRS was introduced by Dr. J.R. Hicks and Prof. R.G.D. Allen (Economics
Concept, n.d.).
Formula of Marginal Rate of Substitution
Where,
MRS= Marginal Rate of Substitution
A= Product A
B= Product B
Example-
Table 2: Consumer’s Marginal Rate of Substitution
Combinations MUA MUB MRS of A for B
1 5 15 -
2 6 10 5:1
3 7 6 4:1
4 8 3 3:1
5 9 2 1:1
3
MRSAB = ΔA/ ΔB