# Supply and Demand and Budget Line

Topics: Supply and demand, Consumer theory, Microeconomics Pages: 5 (1603 words) Published: May 12, 2010
Consider the following equation:
MRSXY < PX/PY
where
MRS = marginal rate of substitution
x and y are two goods
P = price
< = is less than
{draw:frame}
The graph above shown us the indifference curve budget line diagram which explaining the equation MRSXY < P X / PY. There are two ways to measure the consumer preferences or what the consumer wants. The first one is by trying to put a ‘value’ on the satisfaction a consumer obtains from consuming a ‘unit’ of a good. Consumers are assumed to be able measure utility in terms of a ‘util’. However, we cannot find the total utility by using this method. So we can use another way which is by ranking the product. We can say that the consumer is preferred good Y compared to good X. the indifference curve is a curve that shows consumption bundles that give the consumer the same level of satisfaction. So this means that the consumer is satisfied at any point if the indifference curves above. The slope of the indifference curves are downward sloping. For example, the consumer will satisfy when he buys 3 good X and 4 good Y. The meaning of the term budget constraint is what the consumer can afford to buy. The income of the consumer will determine how much he can buy in the market. So, the budget line in the graph above is showing how much good X and Y that the consumer affords to buy. If the slope of the budget line is higher, this means that the consumer afford to buy good X compare to good Y. While if the slope of the budget line is lower, the consumer afford to buy good Y compare to good X. From the graph, we can see that the consumer is not maximizing the satisfaction. This is because the indifference curves are inside the budget line and it intersect at two points which are a and b. At point b, the slope of the indifference curve (MRSxy ) is less than the slope of the budget line (Px/Py). While, at point a, the slope of the indifference curve (MRSxy ) is greater than the slope of the budget line (Px/Py). So the consumer does not maximizing the satisfaction for both point a and b. In order to maximize the satisfaction, the slope of the indifference curve must equal to the slope of the budget line. So at point b, the consumer should reduce the consumption of good X and increase the consumption of good Y until both slope of indifference curve and budget line will become the same. By switching spending away from good X towards good Y, the consumer will be able to reach a higher indifference curve. {draw:frame}

From the graph, we can see that the indifference curve has shift and meet the budget line at the point c. at this point, the slope of the indifference curve and the budget line are the same. So the equation will change to [MRSXY = PX / PY]. At point c, the consumer satisfaction is at the highest place. The consumer choice is the product which been sold in the market. While, the individual demand for a product is the demand of a consumer on that product. The demand on a product will be higher if there are only small choices in the market. People tend to demand more for the product as they cannot find other product. TASK 2

*Definition of Price Elasticity of Demand (PEoD*)
The price elasticity of demand is the measure of how responsive is the quantity demanded to a change in price. There are many types of elasticity in demand which will stand for different types of product in the market. In order to differentiate between them we need to state the definition and the ratio of the elasticity. Relatively Elastic Demand The relatively elastic demand is a demand relationship in which the percentage change in quantity demanded is large in absolute value than the percentage change in price. In other words the percentage change in quantity demanded is larger than the percentage change in price. {draw:frame}

The ratio for the relatively elastic demand is 1< PEoD < Infinity Relatively Inelastic Demand...