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1. 1
I. Discussion and Explanation
1. Cardinal and ordinal utility
 Cardinal utility
Is the utility where the satisfaction derives by consuming a product can be
expressed numerically.
Assumption of cardinal utility - Consumers are rational
-Utility is cardinally measured
- Constant marginal utility of money
- Diminishing marginal utility
- The total utility of a basket of goods depend on
the quality of the individual commodities
 Ordinal utility
Is the utility where the satisfaction derived by consuming a products that
cannot be expressed numerically.
Assumption of ordinal utility - consumer are rational
- Utility is ordinal
- Diminishing marginal rate of substitution
- Total utility
- Consumers preference are consistent

2. 2
2. Indifference curve and budget line
 Indifference curve
Shows a combination of two goods in various that provide equal satisfaction to
an individual. Used in economics to describe the point where individuals have
no particular preference for either one good or another based on their relative
quantities.
 Budget line
Also known as budget constraint, budget line is a graphical declination of all
possible combination of the two commodities that can be bought with provided
income and cost so that the price of each of these combination is equivalent to
the monetary earning of the consumer has an equation of M = 𝑃𝑥x + 𝑃𝑦𝑌

3. 3
3. Marginal utility and marginal rate of substitution
 Marginal utility
Is the extra satisfaction a consumer realizes from an additional unit of the
product, in other word it is the change in total utility that result from the
consumption of one more unit of a product.
 Marginal rate of substitution
Is rate at which consumers are willing to substitute one commodity for another in
such a way that the consumer remains on the same indifference curve. Marginal
rate of substitution of x for y is defined as the number unit of commodity y that
must be given up in exchange for an exchange unit of commodity x so that the
consumer maintained the same level of satisfaction.
Formula of marginal rate of substitution of x for y is

4. 4
4. Production and cost
 Production
Is the process of transforming inputs into outputs. It can also be defined as an act
of creating value or utility. The end product of the production process are output.
 Cost
Is the monetary value all purchased input used production. “to produce goods
and services , firms need factor of production or simples input. To acquire these
input, they have to buy them from resource suppliers”. So cost is the monetary
value of inputs used in the production of an item.
5. GDP and GNP
 GDP (Gross domestic product)
It is the total value of currently produced final good and service and services that
are produced with in a country’s boundary during a given period of time (usually
one year).
- Measures current production only
- GDP = ∑Pi Qi ,Pi = series of prices of out puts produced in different
sector of an economy in certain period
- Qi = the quantity of various final goods and service produced in an
economy.
 GNP (gross national product)
It is the total value of final goods and services currently produced by domestically
owned factors of production in a given period of time (usually 1 year) irrespective
of their geological location.
GNP = GND + NFI (net factor income)
If NFI > 0, then GNP > GDP
If NFI < 0, then GNP < GDP
If NFI = 0, then GNP = GDP

5. 5
II. Workout part
1. Given the demand function P = 20 – 5Q, find the price elasticity of demand
when price of the commodity is 5 Birr per unit. Mention if the demand is
price elastic or inelastic at this point
2. Suppose that the total utility function of a consumer is given by TU(x,y) =
3x2 y and the prices of X and Y are 1 Birr and 2 Birr per unit, respectively. If
the income of the consumer is 600 Birr and if he spends all of his income on
the consumption of commodities of X and Y, find the optimum amount of X
and Y that the consumer will consume at equilibrium and find MRTSx,y.
3. Suppose the cost function is given as C = 135 + 75Q – 15Q2 + Q3. Prepare a
cost schedule (table) showing the TFC, TVC, TC, AFC, AVC, MC, and ATC. Is
this cost function a short run or a long run cost function? Why? Draw the
cost curves on the basis of cost data obtained from the cost function
4. Suppose the short run market price a competitive firm faces is Birr 9 and
the total cost of the firm is: TC = 200 + Q + 0.02Q 2 . Answer the questions
that follow.
(A) Calculate the short run equilibrium output and profit of the firm.
(B) Derive the MC, ATC, and AVC and calculate the values at the short run
equilibrium output.
(C) Calculate the producers’ surplus at the equilibrium output.
(D) Find the output level that will make the profit of the firm zero.

6. 6
Answer as follow: