NEW GENERATION UNIVERSITY COLLEGE
FACULTY OF BUSINESS DEPARTMENT
COMMON COURSE
GROUP ASSIGNMENT
Introduction to Economics
SUBMITTED TO: MR. GETACHEW FEKADU
DATE OF SUBMISSION: 13, JANUAR , 2026
NEW GENERATION UNIVERSITY COLLEGE
FACULTY OF BUSINESS DEPARTMENT
COMMON COURSE
Group members
NAME ID NUMBER
1. Nesredin Mohammed NGUC/25/5499
2. Mahder Wendesen NGUC/25/5509
3. Maryamawit Solomon NGUC/25/5729
4. Bethelhem Daniel NGUC/25/6008
5. Kermay Yitagesu NGUC/25/5730
Part I: Answer the questions accordingly
1. Suppose a particular consumer has 8 birr to be spent on two goods,
A and B. The unit price of good A is 2 birr and the unit price of B is
birr 1. The marginal she gets from consumption of the goods is given
below.
Q MUA MUB
1 36 30
2 24 22
3 20 16
4 18 12
5 16 10
6 10 4
A. Based on the cardinal analysis, what is the combination of
the goods that gives maximum utility to the consumer?
B. What is the total utility at the utility maximization level?
ANSWER:
A. Optimal Combination (Utility Maximization)
Budget = 8 birr
Price of A = 2 birr, Price of B = 1 birr Marginal
utility per birr:
A → 18, 12, 10, 9, 8, 5
B → 30, 22, 16, 12, 10, 4
Allocation order: B1 (1), A1 (2), B2 (1), A2 (2), B3 (1), B4 (1)
Total cost = 8 birr
Optimal bundle = 2 units of A and 4 units of B
B. Total Utility at Optimum
Utility from A = 36 + 24 = 60
Utility from B = 30 + 22 + 16 + 12 = 80
Total Utility = 140
2. Explain the law of variable proportions.
The Law of Variable Proportions, also called the Law of Diminishing
Returns, explains how output changes when one input is increased
while other inputs remain fixed. In the short run, as more units of a
variable factor (like labor) are added to fixed factors (like land or
capital), total output first rises at an increasing rate, then at a
diminishing rate, and finally may decline.
Stages of the Law:
1. Stage I – Increasing Returns
o Total product rises rapidly.
o Marginal product increases with each additional
unit of the variable factor.
Example: the first few workers make better use
of land and tools.
o Cause: Better utilization of fixed resources at first.
2, Stage II – Diminishing Returns
o Total product continues to rise, but more
slowly.
O Marginal product falls, though it remains
positive.
o This is the most rational stage for
producers to operate in.
o Cause: Fixed resources become a bottleneck, limiting
further growth.
3, Stage III – Negative Returns
o Total product decreases.
O Marginal product becomes negative.
o Example: too many workers on the same land reduce
productivity.
o Cause: Excessive use of the variable factor reduces efficiency.
Uses of the Law of Variable Proportions:
o Production decisions: Helps firms decide the optimal level of
input use (usually Stage II).
o Cost analysis: Explains why costs rise after a certain point in
the short run.
o Resource allocation: Guides efficient use of scarce resources.
o Agriculture and industry: Commonly observed in farming
(land fixed, labor added) and factories (machines fixed,
workers added).
o Policy making: Useful for understanding productivity limits
and planning resource distribution.
Note: The Law of Variable Proportions shows that in the short run,
increasing one input while keeping others fixed leads to three stages:
increasing returns, diminishing returns, and negative returns.
Producers usually operate in Stage II, where resources are used most
efficiently.
3. Which stage of short-run production is efficient? Why?
In the short run production, there are three stages of production:
Stage I, Stage II, and Stage III. The efficient stage of short run
production is Stage II, also known as the stage of diminishing
marginal returns. In this stage, the marginal product of labor is
positive but decreasing. This means that as more units of labor are
added, the output still increases, but at a diminishing rate. Stage II is
considered efficient because it maximizes the output while
minimizing the cost of production. At this stage, the marginal cost of
production is still relatively low, and the average total cost is also
decreasing. This means that the firm is producing at the lowest
possible cost, which maximizes its profit. However, after Stage II, the
marginal product of labor becomes negative, leading to a
decrease in output, and the average total cost begins to increase. This
makes the production process inefficient, and the firm should either
scale back production or find ways to increase its efficiency.
4, Utility Maximization
A) Explain briefly what utility maximization is?
B) What is a utility function?
C) What is the criterion that a consumer maximizes her utility? Give
the answer in the form of algebraic expression.
ANSWER:
A. Utility maximization refers to the concept in economics where
individuals or consumers allocate their available resources in a
manner that maximizes their satisfaction or utility. Utility can be
thought of as the satisfaction or happiness derived from
consuming goods and services. The idea is that consumers make
deliberate choices to achieve the highest possible level of utility,
given their budget constraints. This concept is central to the
theory of consumer behavior and underpins decision-making
processes in economics. Because utility maximization explains
how consumers make choices, it becomes the foundation for
understanding demand, resource allocation, and rational behavior
in markets.
From a policy perspective, insights gained from utility maximization can
be used to design better economic policies. For example,
understanding how consumers react to price changes can help in
formulating tax policies, subsidies, and price regulations that
promote economic welfare. Moreover, businesses leverage utility
maximization to develop pricing strategies, marketing campaigns, and
product placements that align with consumer preferences, thereby
enhancing customer satisfaction and loyalty.
B. A utility function is a mathematical representation that quantifies
the satisfaction or happiness a consumer derives from consuming a
combination of goods and services. It measures a consumer’s
preference and satisfaction with different goods or services. As part
of rational choice theory, it helps economists analyze how
consumers make decisions to maximize satisfaction. Utility
functions also inform economists and businesses in sales,
marketing, and product development. Preferences can be ranked
using ordinal utility, which orders choices from most to least
preferred, or cardinal utility, which assigns numerical values to
show the strength of preferences. Utility functions are
mathematically expressed using formulas that capture these
preferences.
C. The criterion for a consumer to maximize her utility can be
expressed algebraically as:
MUx/Px = MUy/Py
Where:
MUx = Marginal Utility of good x
MUy = Marginal Utility of good y
Px = Price of good x
Py = Price of good y
This expression indicates that a consumer maximizes utility when
the marginal utility per dollar spent on each good is equal.
5, Suppose a utility function of a consumer is given as follows, (a) y
= X1X2, (b) Y = X1 + X2 and (c) Y = min [X1; X2] Sketch a few level
sets for the functions:
5. Producer theory
A) Sometimes producer theory is said to be similar to consumer
theory. In what ways are they similar?
B) Describe in words what a production function is, which variables
are typically inputs?
C) What is the difference between short run and long run?
ANSWER:
A. Both producer theory and consumer theory are branches of
microeconomics that use optimization as a core concept. Producer
theory examines how firms maximize profits subject to
technological constraints, while consumer theory explores how
individuals maximize utility subject to budget constraints. Their
similarity lies in the use of mathematical optimization, marginal
analysis, and constraints in decision-making processes. showing that
despite different goals, both follow the same logic of rational choice.
B. A production function is a mathematical representation of the
relationship between inputs and outputs in the production process. It
captures how different combinations of inputs such as labor,
capital, and raw materials are transformed into outputs, reflecting the
efficiency and productivity of a firm’s production technology.
The variables that are typically considered
inputs include:
o Labor (L) → human effort and skills
o Capital (K) → machines, tools, buildings,
equipment
o Land (T) → natural resources like soil,
minerals, water
o Raw Materials (M) → goods consumed
during production
o Technology (A) → methods and knowledge that improve
efficiency
C. The key difference between the short run and the long run in
production analysis is the flexibility of inputs.
In the short run, at least one input is fixed, limiting a firm's ability to
adjust all factors of production, whereas in the long run, all inputs are
variable, allowing firms to fully adjust their production
processes and scale operations as needed.
7, A) State the definition of marginal rate of technical substitution,
MRTS. What does that mean in your own words?
B) Show how to derive the relationship between marginal product of
labor and marginal product of capital and MRTS
ANSWER:
A. MRTS is basically about how one thing can replace another while
keeping the same result.
Example: When we charge my phone, we can use a fast charger for
less time or a slow charger for more time, but either way our phone
ends up fully charged. That’s MRTS, swapping one input for another
without changing the output. It simply shows switching between two
inputs that give the same result.
[Link] Product of Labor (MPL)
The marginal product of labor (MPL) is the extra output that comes
from adding one more worker, while keeping capital fixed. For
example, if output rises from 18 to 23 when the third worker is hired,
then the MPL of that worker is 23−18=5. If the wage is lower than 5,
the worker is worth hiring; if the wage is higher, then it is not.
Marginal Product of Capital (MPK):
The marginal product of capital (MPK) is the extra output that comes
from adding one more unit of capital, like a machine, while keeping
labor fixed. The cost of using capital is called the rental rate, which
works like the “wage” of capital. If MPK is greater than the rental
rate, it makes sense to add more capital.
Marginal Rate of Technical Substitution (MRTS):
The marginal rate of technical substitution (MRTS) shows how much
of one input can be reduced when another input is increased, while
keeping output constant. In simple words, it measures the trade-off
between labor and capital along an isoquant.
Deriving the Relationship
Note: (∂ = partial derivative, meaning we take the derivative with
respect to one variable while holding the other constant.)
1. Production Function Output depends on labor (L) and capital (K):
Q=f(L,K)
2. Marginal Product of Labor (MPL): MPL=∂Q/∂L Extra output
from one more unit of labor. Marginal Product of Capital (MPK):
MPK=∂Q/∂K
Extra output from one more unit of capital.
3. MRTS: MRTS𝖫,ₖ = -dK/dL
4. Total Differential of Output:
dQ = (∂Q/∂L × dL) + (∂Q/∂K × dK)
5. Substitute marginal products: dQ = MPL × dL + MPK × dK
6. Constant Output (Isoquant Condition) On an isoquant, output is
constant, so: dQ =0
MPL × dL + MPK × dK = 0
7. Rearranging: MPK × dK = -MPL × dL
Solve for slope: dK/dL = -MPL/MPK
8. Substitute into the definition of MRTS: MRTS𝖫,ₖ = -dK/dL
9. MRTS𝖫,ₖ = MPL/MPK
Overall Relationship: MRTS is the ratio of the marginal product of
labor to the marginal product of capital. It shows how much capital
can be reduced when labor increases, while keeping output the same.
This relationship comes directly from the production function and the
condition of constant output along an isoquant.
9, In the input output relationship of a production function, there is
an infliction point. Explain what it is meant with an infliction point.
An inflection point in a production function refers to the stage
where the rate of change of output shifts. This concept is crucial in
economics and production management because it highlights how
efficiently inputs are being used.
At the inflection point, the production curve changes curvature:
output moves from increasing at an increasing rate to increasing at a
decreasing rate. In other words, output continues to rise, but
each additional unit of input contributes less than before. This point
marks the transition from Stage I (increasing returns) to Stage II
(diminishing returns) in the law of variable proportions. Stage II is
considered the efficient range of production, where firms aim to
operate. The inflection point therefore acts as a guide for managers
and economists, showing when inputs begin to lose efficiency and
helping determine the optimal combination of labor and capital.
10, The maximum point on the APP is called point of intensive margin,
because the margins are exhausted. Explain what means.
The maximum point on the Average Physical Product (APP) curve is
called the point of intensive margin, because at this stage the margins
are exhausted. APP is the total output divided by the number of units
of the variable input, showing the average
productivity per unit. Marginal Physical Product (MPP), on the other
hand, is the additional output produced by adding one more unit of
the variable input.
At first, as more input is added, both APP and MPP rise due to
specialization and better use of fixed resources. Eventually, MPP
begins to decline, and when APP reaches its maximum, MPP is equal
to APP.
This maximum point is the point of intensive margin, where average
productivity is at its highest. Beyond this stage, adding more input
causes APP to fall, meaning efficiency per unit of input decreases and
the margins are exhausted.
In economics and production management, the point of intensive
margin is significant because it identifies the limit of average
efficiency. It guides firms and managers to recognize when inputs
begin to lose productivity and helps determine the optimal use of
labor and capital, ensuring resources are employed in the efficient
range of production.