ECS2601
EXAM
PACK
2025
, lOMoARcPSD|58918787
ECS2601
ASSIGNMENT 01
DUE DATE: 2 April 2025
UNIQUE NUMBER: 655050
Solutions
This assignment covers: Learning units 1-4 and 6
Question 1: (15 marks)
1.1 In microeconomics we need to make certain assumptions about the preferences
of consumers. Critically evaluate any two of these assumptions. (4)
Completeness: Consumers can compare and rank all possible baskets of goods and
services. Given two baskets (A and B), consumers will A>B, B>A or indifferent (equally
satisfied). Important is that these preferences ignore costs.
Transitivity: This means preferences are consistent, in the sense that if bundle A is preferred
to bundle B and bundle B is preferred to bundle C, then bundle A is preferred to bundle C
More > less: this means all goods are desirable, and that consumers always prefer to have
more of each good. (Note that we focus on ‘goods’ and ignore goods that are ‘bad’, e.g.
pollution)
Diminishing marginal rate of substitution: this means that indifference curves are convex,
and that the slope of the indifference curve increases (becomes less negative) as we move
down along the curve. As a consumer moves down her indifference curve she is willing to give
up fewer units of the good on the vertical axis in exchange for one more unit of the good on
the horizontal axis. This assumption also means that balanced market baskets are generally
preferred to baskets that have a lot of one good and little of the other.
1.2 Critically evaluate why the MRS between two goods must equal the ratio of the
price of the goods for the consumer to achieve maximum satisfaction. (3)
The Marginal rate of substitution (MRS) describes the rate at which the consumer is
willing to trade off one good for another to maintain the same level of satisfaction. The
ratio of prices describes the trade-off that the consumer can make between the same
two goods in the market. The tangency of the indifference curve with the budget line
Downloaded by Jonah Njenga ()
, lOMoARcPSD|58918787
represents the point at which the trade-offs are equal, and consumer satisfaction is
maximized. If the MRS between two goods is not equal to the ratio of prices, then the
consumer could trade one good for another at market prices to obtain higher levels of
satisfaction.
For example, if the slope of the budget line (the ratio of the prices) is -4, the consumer
can trade 4 units of Y (the good on the vertical axis) for one unit of X (the good on the
horizontal axis).
If the MRS at the current bundle is 6, then the consumer is willing to trade 6 units of Y
for one unit of X. Since the two slopes are not equal the consumer is not maximizing her
satisfaction. The consumer is willing to trade 6 but only has to trade 4, so she should
make the trade. This trading continues until the highest level of satisfaction is achieved.
As trades are made, the MRS will change and eventually become equal to the price
ratio.
1.3 Comment on any two of the following topics related to elasticities: (4)
(a) Arc elasticity of demand: Price elasticity calculated over a range of prices. Rather
than choosing either the initial or final price, we use an average of the two. Thus arc
elasticity will always lie somewhere (although not necessarily halfway) between the
point elasticities calculated for the lower and higher prices. Formula:
EP = ( ΔQ ΔP )(P Q )
(b) Cross price elasticity of demand: Percentage change in the quantity demanded of
one good resulting from a 1-percent increase in the price of another
(c) Infinite elastic demand: Principle that consumers will buy as much of a good as they
can get at a single price, but for any higher price the quantity demanded drops to zero,
while for any lower price the quantity demanded increases without limit (i.e. very
sensitive to price changes).
Mostly a theoretical concept but goods and services with close substitutes are more
likely to exhibit infinite elasticity characteristics, as consumers can easily switch
between alternatives. Examples could include staples such as rice or maize meal.
(d) Price elasticity of supply: Percentage change in quantity supplied resulting from a
1-percent increase in price. Usually positive since a higher price gives producers an
incentive to increase output.
Downloaded by Jonah Njenga ()
, lOMoARcPSD|58918787
1.4 Discuss the likely shape the indifference curves related to the following items will
have (makes sure to also include a graph in your explanation): (4)
(a) Printers and ink cartridges
Perfect compliments
Two goods for which the MRS is zero or infinite; i.e. you cannot use the one without the other.
The indifference curves are shaped as right angles
(a) A box of chicken wings bought at different take away stores (you may choose
which stores! You can also assume that they include the same number of wings)
Perfects Substitutes
Two goods for which the marginal rate of substitution of one for the other is a constant. I.e.
almost identical products, which the consumer is both willing and able to use
Downloaded by Jonah Njenga ()
EXAM
PACK
2025
, lOMoARcPSD|58918787
ECS2601
ASSIGNMENT 01
DUE DATE: 2 April 2025
UNIQUE NUMBER: 655050
Solutions
This assignment covers: Learning units 1-4 and 6
Question 1: (15 marks)
1.1 In microeconomics we need to make certain assumptions about the preferences
of consumers. Critically evaluate any two of these assumptions. (4)
Completeness: Consumers can compare and rank all possible baskets of goods and
services. Given two baskets (A and B), consumers will A>B, B>A or indifferent (equally
satisfied). Important is that these preferences ignore costs.
Transitivity: This means preferences are consistent, in the sense that if bundle A is preferred
to bundle B and bundle B is preferred to bundle C, then bundle A is preferred to bundle C
More > less: this means all goods are desirable, and that consumers always prefer to have
more of each good. (Note that we focus on ‘goods’ and ignore goods that are ‘bad’, e.g.
pollution)
Diminishing marginal rate of substitution: this means that indifference curves are convex,
and that the slope of the indifference curve increases (becomes less negative) as we move
down along the curve. As a consumer moves down her indifference curve she is willing to give
up fewer units of the good on the vertical axis in exchange for one more unit of the good on
the horizontal axis. This assumption also means that balanced market baskets are generally
preferred to baskets that have a lot of one good and little of the other.
1.2 Critically evaluate why the MRS between two goods must equal the ratio of the
price of the goods for the consumer to achieve maximum satisfaction. (3)
The Marginal rate of substitution (MRS) describes the rate at which the consumer is
willing to trade off one good for another to maintain the same level of satisfaction. The
ratio of prices describes the trade-off that the consumer can make between the same
two goods in the market. The tangency of the indifference curve with the budget line
Downloaded by Jonah Njenga ()
, lOMoARcPSD|58918787
represents the point at which the trade-offs are equal, and consumer satisfaction is
maximized. If the MRS between two goods is not equal to the ratio of prices, then the
consumer could trade one good for another at market prices to obtain higher levels of
satisfaction.
For example, if the slope of the budget line (the ratio of the prices) is -4, the consumer
can trade 4 units of Y (the good on the vertical axis) for one unit of X (the good on the
horizontal axis).
If the MRS at the current bundle is 6, then the consumer is willing to trade 6 units of Y
for one unit of X. Since the two slopes are not equal the consumer is not maximizing her
satisfaction. The consumer is willing to trade 6 but only has to trade 4, so she should
make the trade. This trading continues until the highest level of satisfaction is achieved.
As trades are made, the MRS will change and eventually become equal to the price
ratio.
1.3 Comment on any two of the following topics related to elasticities: (4)
(a) Arc elasticity of demand: Price elasticity calculated over a range of prices. Rather
than choosing either the initial or final price, we use an average of the two. Thus arc
elasticity will always lie somewhere (although not necessarily halfway) between the
point elasticities calculated for the lower and higher prices. Formula:
EP = ( ΔQ ΔP )(P Q )
(b) Cross price elasticity of demand: Percentage change in the quantity demanded of
one good resulting from a 1-percent increase in the price of another
(c) Infinite elastic demand: Principle that consumers will buy as much of a good as they
can get at a single price, but for any higher price the quantity demanded drops to zero,
while for any lower price the quantity demanded increases without limit (i.e. very
sensitive to price changes).
Mostly a theoretical concept but goods and services with close substitutes are more
likely to exhibit infinite elasticity characteristics, as consumers can easily switch
between alternatives. Examples could include staples such as rice or maize meal.
(d) Price elasticity of supply: Percentage change in quantity supplied resulting from a
1-percent increase in price. Usually positive since a higher price gives producers an
incentive to increase output.
Downloaded by Jonah Njenga ()
, lOMoARcPSD|58918787
1.4 Discuss the likely shape the indifference curves related to the following items will
have (makes sure to also include a graph in your explanation): (4)
(a) Printers and ink cartridges
Perfect compliments
Two goods for which the MRS is zero or infinite; i.e. you cannot use the one without the other.
The indifference curves are shaped as right angles
(a) A box of chicken wings bought at different take away stores (you may choose
which stores! You can also assume that they include the same number of wings)
Perfects Substitutes
Two goods for which the marginal rate of substitution of one for the other is a constant. I.e.
almost identical products, which the consumer is both willing and able to use
Downloaded by Jonah Njenga ()
