CA Foundation P4 · Chapter 2
Theory of Demand and Supply MCQs with Answers
15 multiple-choice questions on Theory of Demand and Supply for CA Foundation P4 Business Economics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
The law of demand states that, other things remaining constant:
- A) Quantity demanded of a good varies inversely with its price
- B) Quantity demanded varies directly with the price of the good
- C) Demand increases whenever the consumer's income rises
- D) Quantity demanded is independent of price
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Answer: A) Quantity demanded of a good varies inversely with its price
The law of demand describes an inverse relationship between price and quantity demanded, ceteris paribus. The effect of income is a separate determinant that shifts the demand curve and is not the subject of the law.
Question 2
Which of the following is an exception to the law of demand?
- A) A normal good
- B) A good with many close substitutes
- C) A complementary good
- D) A Giffen good
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Answer: D) A Giffen good
For a Giffen good (an inferior staple with a strong negative income effect that outweighs the substitution effect), quantity demanded rises when price rises, giving an upward-sloping demand curve. Normal goods, substitutes and complements all follow the law of demand.
Question 3
For a normal good, an increase in consumers' income will cause:
- A) A movement down along the same demand curve
- B) A leftward shift of the demand curve
- C) A rightward shift of the demand curve
- D) A movement up along the same demand curve
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Answer: C) A rightward shift of the demand curve
A change in any determinant other than the good's own price shifts the demand curve. For a normal good, higher income raises demand at every price, shifting the curve to the right. Movements along the curve are caused only by changes in the good's own price.
Question 4
The price of a product rises from Rs. 20 to Rs. 25 and quantity demanded falls from 400 units to 300 units. Using the percentage (proportionate) method with the original values as base, price elasticity of demand is:
- A) 0.8
- B) 1.25
- C) 2
- D) 1 (unitary elastic)
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Answer: D) 1 (unitary elastic)
Percentage change in quantity = (300 - 400) / 400 x 100 = -25%. Percentage change in price = (25 - 20) / 20 x 100 = +25%. Ed = 25 / 25 = 1 (ignoring the minus sign). So demand is unitary elastic over this range.
Question 5
When the price of a good rises from Rs. 10 to Rs. 12, quantity demanded falls from 150 units to 100 units. Using the arc (midpoint) method, price elasticity of demand is:
- A) 1.67
- B) 2.5
- C) 2.2
- D) 1.83
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Answer: C) 2.2
Arc elasticity = (dQ / average Q) / (dP / average P). dQ = 50, average Q = (150 + 100)/2 = 125, so 50/125 = 0.4. dP = 2, average P = (10 + 12)/2 = 11, so 2/11 = 0.1818. Ed = 0.4 / (2/11) = 0.4 x 11/2 = 2.2. Using the original base instead gives (50/150)/(2/10) = 1.67, a common error.
Question 6
When the price of a good falls, total expenditure on it remains unchanged. According to the total outlay method, demand is:
- A) Perfectly inelastic
- B) Relatively elastic
- C) Relatively inelastic
- D) Unitary elastic
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Answer: D) Unitary elastic
Under Marshall's total outlay method: if total expenditure rises when price falls, demand is elastic (e > 1); if it falls, demand is inelastic (e < 1); if it remains the same, demand is unitary elastic (e = 1).
Question 7
A household's income rises from Rs. 20,000 to Rs. 25,000 per month and its consumption of coarse grain falls from 50 kg to 45 kg. The income elasticity of demand (original base) and the nature of the good are:
- A) -0.4; inferior good
- B) +0.4; normal necessity
- C) -2.5; inferior good
- D) +2.5; luxury good
Show answer & explanation
Answer: A) -0.4; inferior good
Percentage change in quantity = (45 - 50)/50 x 100 = -10%. Percentage change in income = (25,000 - 20,000)/20,000 x 100 = +25%. Income elasticity = -10 / 25 = -0.4. A negative income elasticity indicates an inferior good. -2.5 results from inverting the ratio.
Question 8
The price of tea rises by 10% and, as a result, the quantity demanded of coffee rises by 6%. The cross elasticity of demand for coffee with respect to the price of tea is:
- A) +0.6, indicating that tea and coffee are substitutes
- B) -0.6, indicating that they are complements
- C) +1.67, indicating that they are substitutes
- D) -1.67, indicating that they are complements
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Answer: A) +0.6, indicating that tea and coffee are substitutes
Cross elasticity = % change in quantity of coffee / % change in price of tea = 6 / 10 = +0.6. A positive cross elasticity means a rise in the price of one good increases demand for the other, which is the case of substitutes. 1.67 inverts the ratio.
Question 9
The demand function for a product is Q = 100 - 4P. What is the point price elasticity of demand at P = Rs. 15?
- A) 0.67
- B) 4
- C) 0.6
- D) 1.5
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Answer: D) 1.5
At P = 15, Q = 100 - 4(15) = 40. dQ/dP = -4. Point elasticity = (dQ/dP) x (P/Q) = 4 x 15/40 = 60/40 = 1.5 (absolute value). 0.67 is the inverse of the correct value; 0.6 uses P/Q = 15/100 incorrectly.
Question 10
A consumer spends her entire income on goods X and Y. Px = Rs. 6, Py = Rs. 5, and at her current purchases MUx = 30 utils and MUy = 20 utils. To maximise satisfaction she should:
- A) Buy more of X and less of Y
- B) Buy more of Y and less of X
- C) Make no change, as she is in equilibrium
- D) Buy more of both X and Y
Show answer & explanation
Answer: A) Buy more of X and less of Y
Equilibrium requires MUx/Px = MUy/Py. Here MUx/Px = 30/6 = 5 utils per rupee and MUy/Py = 20/5 = 4 utils per rupee. The last rupee spent on X yields more, so she should shift spending towards X; MUx will fall and MUy will rise until the ratios are equal. With income fully spent she cannot buy more of both.
Question 11
The marginal utilities a consumer derives from successive units of a commodity are 50, 40, 30, 20 and 10 utils. One util equals Re 1 and the market price is Rs. 20 per unit. If the consumer buys up to the point where marginal utility equals price, the consumer surplus is:
- A) Rs. 60
- B) Rs. 140
- C) Rs. 50
- D) Rs. 70
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Answer: A) Rs. 60
The consumer buys units while MU is at least Rs. 20, i.e., 4 units (MU of the 4th unit = 20). Total utility of 4 units = 50 + 40 + 30 + 20 = Rs. 140. Amount paid = 4 x 20 = Rs. 80. Consumer surplus = 140 - 80 = Rs. 60. Rs. 50 would result from buying all 5 units (150 - 100).
Question 12
An indifference curve is normally convex to the origin because of:
- A) Increasing marginal utility
- B) Constant marginal rate of substitution
- C) The law of demand
- D) Diminishing marginal rate of substitution
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Answer: D) Diminishing marginal rate of substitution
As a consumer substitutes X for Y along an indifference curve, she is willing to give up fewer and fewer units of Y for each additional unit of X; i.e., MRSxy diminishes. This makes the curve convex. A constant MRS would produce a straight-line indifference curve (perfect substitutes).
Question 13
A consumer has an income of Rs. 600 to spend on goods X (Rs. 20 each) and Y (Rs. 30 each). If her income and both prices are doubled, her budget line will:
- A) Shift parallel outwards
- B) Remain unchanged
- C) Shift parallel inwards
- D) Become steeper
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Answer: B) Remain unchanged
The intercepts of the budget line are Income/Px and Income/Py. Originally 600/20 = 30 units of X and 600/30 = 20 units of Y. After doubling: 1,200/40 = 30 and 1,200/60 = 20. The slope -Px/Py = -40/60 = -2/3 is also unchanged. Hence the budget line does not change.
Question 14
When the price of a good rises from Rs. 40 to Rs. 50, quantity supplied rises from 200 units to 260 units. Price elasticity of supply (original base) is:
- A) 0.83
- B) 1.5
- C) 0.6
- D) 1.2
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Answer: D) 1.2
Percentage change in quantity supplied = (260 - 200)/200 x 100 = 30%. Percentage change in price = (50 - 40)/40 x 100 = 25%. Es = 30/25 = 1.2, so supply is relatively elastic. 0.83 is the inverse.
Question 15
A straight-line supply curve that passes through the origin has a price elasticity of supply:
- A) Equal to one at every point, irrespective of its slope
- B) Greater than one at every point
- C) Less than one at every point
- D) That depends on how steep the line is
Show answer & explanation
Answer: A) Equal to one at every point, irrespective of its slope
For a linear supply curve Q = bP passing through the origin, Es = (dQ/dP)(P/Q) = b x P/(bP) = 1. This holds at every point regardless of slope. A linear supply curve cutting the price axis has Es > 1, and one cutting the quantity axis has Es < 1.