The Institute of Chartered Accountants of

Bangladesh
An Assignment of Economics

Submitted To:
Mr. Md. Aoulad Hosen

Submitted By:
Md. Aminul Islam Khan
Roll No. 414
Section-F
Batch-13th
Session: January-March 2006

Date of Submission: - February 2, 2006.

1. What is production possibility curve frontier? Explain by

graph.
The production possibility curve shows the maximum output of anyone
commodity that the economy can produce together with the prescribed
quantities of other commodities produced and the resources utilized. In
short, the production possibility curve tells us what assortment of
goods and services the economy can produce with the resources and
techniques at its disposal. The assortment on the curve is regarded as
technological efficient and bellow it as inefficient, for the simple reason
that the economy is capable of producing a bigger assortment at least
in respect of one commodity without decreasing any other. Any
assortment, which is beyond the frontier, is really beyond the
economys power and is unattainable. The production possibility curve
depicts the societies menu of choices.
Y

.S

500 M

Product-B

400

Unattainable Combination

.t

300

O
P

200

Production Possibility

frontier
100

R
Q
0

30

50
Product-A

70

90

100

In the above figure M and Q are two extreme points that represent
production of two items, Product-A and Product-B respectively, N, O, P,

R are the combination of two products simultaneously, which represent

the possibilities of two products. If producers want to produce some
product-A then they have to sacrifice extent limit of Product-B.
In the diagram, the curve marks the production possibility frontier and
all points on the curve represent production possibility, the points
inside the curve are attainable combination and those outside such as
s, t are unattainable combinations. Any point inside the curve
represents an underutilization of resources or under-employment. A
fuller utilization will shift the curve outwards.
Increase in the resources at the disposal of the firm will take it to a
higher possibility curve.

2. Discuss the law of demand.

Demand:
All desires and need are not demand. When, however, the person
desiring is willing and able to pay for what he desires, the desire is
changed into demand. Demand is always at a price. According to
Bober, By demand we mean the various quantity of a given
commodity or service which consumers would buy in one market in a
given period of time and various prices, or at various incomes, or at
various prices of related goods.
Law of demand:
This law simply expresses the relation between quantity of a
commodity demanded and its prices. The law states that demand
varies

inversely

with

price,

not

necessarily

proportionately.

In

Marshalls words, The greater the amount to be sold, the smaller must
be the price at which it is offered in order that it may find purchasers;

or in other words, the amount demanded increases with a fall in price

and diminishes with a rise in price. Obviously, the law of demand is
based on the law of diminishing marginal utility. In other words, it is the
law of diminishing marginal utility which explains the law of demand.
Demand thus is a function of price, it varies with price and can be
expressed as D=F (P). Here, D is Demand P is Price.
It may also be added that no proportionality in the change is implied. if
the price falls by 10 percent it doesnt follow that the demand will
increase exactly by 10 percent. We can also say that the demand will
extend when the price falls, but we cant say how much. This will
depend on the elasticity of demand, which we shall discuss shortly. It is
described with a demand curve in following
Y
K
P2
P
P1

Demand Curve

According to above curve, along OX are represented the quantities of

the good purchased and along OY the prices. It will be seen that at the
price OP, OM quantity is purchase; at OP 1 the quantity purchased is ON
and at OP2 price OL. As the price falls, more is purchased and vise
versa. The demand curve is also known as the average revenue curve,
because the price paid by the consumer is revenue per unit for the
seller.

Limitations of the law:

There are, however, certain exceptions to the law of demand. the
following exceptions tot he law of demand may be indicated: i. Change in taste or fashion: According to the law of demand, when price falls, demand is
expected to increase. But if in the mean time consumers testes
have under gone a change or if the commodity has gone out of
fashion, more may not be demanded even if the price falls.
ii. Change in income: A rise in price is likely to result in a diminution of demand
according to the law of demand. But if the consumers income has
gone up, he may be willing to buy more inspite of the rise in price.
iii. Change in other Prices: The law of demand says that, if the price of a commodity, say tea,
falls, more tea will be demanded. But if the price of coffee falls
even more heavily more tea may not be purchased; instead more
coffee may be purchased. This is in contravention of the law of
demand.
iv. Discovery of substitutes: Acting on the Law of demand, India may lower the price of Jute
may abolishing or reducing export duty to boost her sells of Jute.
But the discovery of cheap substitutes like paper bags may nullify
our efforts and more Jute may not be demanded even if the prices
of Jute falls.
V. Anticipatory changes in prices may also upset the law of
demand. It is often seen that there is stockpiling of commodities
and larger purchases even though the prices are rising. This may
be due to the fact that either on account of the danger of work or
widespread failure of range, shortage is feared or the prices in
may in future go up still higher.

VI. The law of demand does not hold good also when a commodity is
such that its use confers distinction. In case of such a
commodity, a fall in its price will keep off the eligible purchasers,
because the use of a cheap commodity cant be considered as a
mark of distinction.
The above are a few exceptions to the law of demand. By and large,
however, the law holds good. That is, a rise in price decreases demand
and a fall in price increases it.
3. What is the law of diminishing marginal utility? Derivation of the
demand curve from law of diminishing marginal utility.
Law of Diminishing marginal Utility: Satisfaction of human wants follows some very important laws and one
of them is the law of diminishing marginal utility. The law refers to the
common experience of every consumer. suppose a person starts eating
pieces of bread one after another. The first toast gives him great
pleasure. By the time he starts taking the second, the edge of his
appetite has been blunted, and the second toast, meeting with a less
urgent want, yields less satisfaction; the satisfaction of the third will be
less than that of the second; that of the fourth less than that of the
third, and so on. The additional satisfaction will go on decreasing with
every successive toast till it drops down to zero; and if the consumer is
forced to take more the satisfaction may become negative, or the
utility may change into disutility.
When our hypothetical consumer
goes on taking toasts, the extra

Total
Utility
(Units
of
Satisfactions)

Marginal Utility
(Units
of
Satisfactions)

1
2
consumption of each successive
3

20
38
53

20
18
15

satisfaction that he gets by the

Unit (Toasts)

toast goes on decreasing till it

4
goes down to zero at the 6th, and 5
6
then it becomes negative. The 7
total utility, however, goes on 8

64
70
70
62
46

11
6
0
-8
-16

increasing until the consumption

of the 5th; but it is worth nothing
that it increases at a diminishing
rate.
Marshal States the law thus- The additional benefit which a person derives from a
given increase of his stock of a thing diminishes with every increase in stock t6hat he
already has. We might add that with every diminution of his stock the marginal
utility will go on increasing. in other words, the marginal utility varies inversely with
the stock. Although not necessarily in the same proportion.

9
8

7
6
5
4
3
2
1
0

Q
R
S

T
W
H
M1

M2

M3

M4

M5

M6

M7

M8

M9

In this figure, a curve MU has been drawn

Z which slopes downward from
left to right.
This is the
diminishing
marginal utility
MU curve. It shows that
Diminishing
Marginal
utility Curve
as the utility of the commodity with the consumer increases, its
marginal utility decreases. When he has OM 1 quantity, the marginal
utility is M1P and when the quantity increases to OM 2, the marginal
utility decreases M2Q, in the same manner the marginal utility of the
commodity OM3, is M3R, of OM4 it is M4S, of OM5 it is M5T, of OM6 it is
M6W and of OM7 it is M7H. When the quantity increases to OM 8, the
marginal utility drops to zero and it becomes negative when the
consumer comes to have OM9 quantity.

Limitations of the Law: The law of diminishing marginal utility as enunciated above, is based
on the certain assumption:
I. Suitable units:
It is assumed that the commodity is taken in suitable units. If we began
taking water by spoonfuls when thirsty, or if we want to judge the
utility of the Morsels rather than the full chapattis, our thrust or
hunger will be at first stimulated rather than assuaged, and the utility
may therefore, at first, rise instead of falling. But, sooner or later, a
point will be reached when utility will begin to diminish. Unless,
therefore, the units are of a suitable size, the law will not hold good.
The initial quantity should be greater than the critical minimum.
II. Suitable Time:
It is further assumed that the commodity is taken with in a certain
time, otherwise the law will not apply. If you take your first meal at
10 am and the next at 2pm, there is no reason why the utility of
the second meal may be less. But incase you are compelled to
take the second meal within hour of your having taken the first,
the law will apply and the utility of the second meal will be less.
III. No changes in consumers Tastes: Another assumption is that the character of due consumer does
not change. The consumer must not, for instance, have developed
a craving. The more music one hears, the more literature one
reads, the more wine a drunkard takes, the more money a miser
has, the greater is the utility in each case. This is so because the
character of the consumer has undergone a change. More reading
lifts a person to a higher plane, and he is able to appreciate and
enjoyed literature better than he could before. Similarly, a

drunkard is said to enjoy each successive peg more than the

previous one.
IV. Normal Persons: The Law of diminishing marginal utility applies to normal persons
and not two eccentric or abnormal persons like misers. In other
words, we assume rational behavior on the part of the consumers.
In case they behave in a queer and irrational manner, the law will
not hold good.
V. Constant Income:
It is also essential that the income of the consumer remains the
same. Any change in income will falsify the law. For instance, a
rise in a mans income may raise in his eyes the value of the
various plots in his big compound of which he could not much use
before.
VI. Rare Collections: In the case of the rare collections, the law does not hold good. If,
for instance, a man is collecting ancient coins, the more he is able
to collect the greater will be his satisfaction. Hence, in such cases
the law of diminishing marginal utility does not hold good.
VII. Change in the other peoples Stock: The law says that marginal utility decreases when there is an
increase in our stock. But, in some cases, the utility changes, not
because of a change in what we have but because of a change in
other peoples stock.

VIII. Other possessions: Utility also depends on our other possessions. The law ignores the
relation of complementarily.
IX. Fashion: Further, utility depends on fashions too. The utility of my dress
goes up when that dress comes in fashion. If, on the other hand, it
goes out of fashion, the utility goes down.

X. Not applicable to Money: The law does not apply to money as it is said that more money he has,
the more he wants. But as explain below, it does apply to money too.
The law of diminishing utility, like other economic laws, is merely a
statement of a tendency. It depends upon so many conditions. If the
conditions are not full filled, the law does not apply as in the many
exceptional cases mentioned above.
Derivation of the demand curve from law of diminishing
marginal utility.
The law of diminishing marginal utility states that the marginal utility
of a good (expressed in terms of money) to a consumer decreases as
the quantity consumed increases. This means that the marginal utility
curve of a good is a downward sloping curve as shown in the figure

We have already known that a

consumer is in equilibrium when
the marginal utility of a good

Marginal Utility and Price

below:
Y

R
R O

P
M1

M2

Quantity
MU

equals its price. Now when the

price of the good falls for example
from OR to OR, the consumer
must buy more than before. That
is OM2 instead of OM1 so that the
marginal utility PM2 equals price
OR. From this it follows that the
diminishing marginal utility curve
leads us to a downward sloping
demand curve, which means that
more of a good is purchased as its
price falls. This can be seen in the
above figure.
At the price OR the consumer is in equilibrium at the quantity of the
good OM1 since it represents a positions of equality between marginal
utility PM1 and the Price OR. Now if the price comes down from OR to
OR, this equality between the marginal utility and price is disturbed,
because the marginal PM1 is greater than the price OR. This equality is
restored only, when the consumer buys OM 2 instead of OM1, than the
marginal utility PM2 is equal to the price OR. This means buying more
when the price falls and this is precisely the law of demand and what
the demand curve shows.
We have thus derived the law of demand, which states that the
quantity demanded of a good varies inversely with its price. In other
words, other things remaining the same, the quantity demanded
increases when the price falls and vice versa. This is the well-known
Marshallian law of demand and it is based on the law of diminishing
marginal utility.
4. What do you mean by consumer equilibrium? Discuss by
graph.

Where the consumer attains a position of maximum satisfaction and

would have no further incentive to make any change in the quantity of
the commodity purchased. The law of diminishing marginal utility tells
us the position of a consumers equilibrium in the case of a onecommodity purchase. He will go on buying successive units of the
commodity till the marginal utility of the commodity becomes equal to
price. If the price falls, he will buy more and the marginal utility will
come down to the level price. On the other hand, if the price goes up,
naturally less will be purchased and the marginal utility goes up till it
reaches the new higher level of price. In short, equality between
marginal utility and price indicates the positions of consumers
equilibrium when only one commodity is being purchased and
consumed.
In case the consumer is buying two commodities P and Q, the position
of equilibrium will be determined according to the law of equi-marginal
utilities. It has already been stated that a consumer derives maximum
satisfactions when the marginal utilities of the two commodities are
equal. In case they are not equal, adjustment will be made in the
matter of quantities purchased till the marginal utilities of the two
commodities are equalized. This is position of maximum satisfaction.
The consumer always wants to keep this equilibrium. But to achieve
this equilibrium there are some conditions, which stated below:
I. The Choice of consumer will be unchanged.
II. The product should be similar
III. The market should be steady and price level unchanged
IV. The income of consumer should be limited
Y A
Commodity-Q

In the figure E is the consumers

equilibrium because E is the point
where
indifference
curve
C

4
O

C2
E
Commodity-PC1C
3
B
X

intersects with budget line AB.

and consumer is satisfier by
purchasing 3 units of commodity-P
and 4 units of Q commodity with
his limited income. Other hand C1
indifference curve shows the less
satisfaction and C2 indifference
curve
shows
the
higher
satisfaction. So, C curve is the
consumer equilibrium.
5.a. Find out the relationship among Average Fixed Cost,
Average Variable Cost and Average Cost.
Average cost is the sum of average fixed cost and average variable
cost. So, if we find out average cost, we must need the average
variable cost and average fixed cost.
Y
MC
AC
Cost

AVC
AFC

Output

Average fixed average variable and average cost

In the above figure, we have drawn both the average fixed cost curve
and the average variable cost curve. The total fixed cost being fixed for
all units of output, Average fixed cost is a falling curve in the shape a
rectangular hyperbola. Average variable cost curve at first falls and
then as there emerged the diseconomies of large production.
By adding the two costs, average fixed and average variable, we get
the average cost per unit of output. This is the relation among AFC,
AVC and AC.

5.b. Relationship among total cost, marginal cost and average

cost.
Unit of Output
0
1
2
3
4
5
6

Total Cost
30
40
48
54
62
80
102

Average Cost
40
24
18
15.5
16
17

Marginal Cost
10
8
6
8
18
22

In the table, we see that when total cost is increasing at increasing

rate, its corresponding marginal cost is rising. When total cost is
increasing at a decreasing rate, its corresponding marginal cost is
falling an when total cost has reached the maximum i.e., it is
increasing at a zero rate, its corresponding marginal cost is zero.
In the figure, when marginal cost is less than average cost, AC is falling
a when marginal cost is greater the average cost is rising. This is the
relation among there.
Y

MC
AC

Cost

TC

X
Output

Average marginal cost and total cost

In the very long run all cost are variable. Total cost of a given output is
the sum of total fixed cost and Total variable cost. As far as the total
fixed cost is concerned. It remains constant for all unit of out put. But

we have to incur more variable cost when output is increased total

variable cost is zero.
In the long run total cost increased output though the rate of increase
input, extend production for long time and more output there is no
fixed cost. All of are variable.

5.c. Find out the relation between LTC-long run total cost and
TC- short run total cost.
In the long run, all cost are variable.
Y
S
P
P
S

Variable cost
Q
Cost
Fixed
M

Q1
M1

T
X

In the figure, SS is the total cost curve it includes the total fixed cost
(the distinguish between two curve ST and x-axis) and the total
variable cost (represented by the distance between the curve SS and
ST). In the long run only variable cost are the total cost. So, the

distinguish between two curve SS and ST is the LTC. But in the short
run TC is the sum of variable cost unless fixed cost that is the
distinguish between SS and ST and ST and OX are the TC.
Finally, we can say we get LTC when all cost are variable, but get TC
when all cost are variable and fixed. It is the relation between LTC and
TC.