Wk8 DQ - Managerial Eonomics
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Baye_9e_Chapter_041.pptxThe Theory of Individual Behavior
© 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 4
Learning Objectives
Explain four basic properties of a consumer’s preference ordering and their ramifications for a consumer’s indifference curves.
Illustrate how changes in prices and income impact an individual’s opportunities.
Illustrate a consumer’s equilibrium choice and how it changes in response to changes in prices and income.
Separate the impact of a price change into substitution and income effects.
Show how to derive an individual’s demand curve from indifference curve analysis and market demand from a group of individuals’ demands.
Illustrate how “buy one, get one-free” deals and gift certificates impact a consumer’s purchase decisions.
Apply the income-leisure choice framework to illustrate the opportunities, incentives, and choices of workers and managers.
© 2017 by McGraw-Hill Education. All Rights Reserved.
2
Consumer Behavior
Consumer opportunities
Set of possible goods and services consumers can afford to consume.
Consumer preferences
Determine which set goods and services will be consumed.
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4-3
Consumer Behavior
3
Properties of Consumer Preferences
Property 1- Completeness: For any two bundles of goods either:
.
.
.
Property 2- More is better
If bundle has at least as much of every good as bundle and more of some good, bundle is preferred to bundle .
Property 3- Diminishing marginal rate of substitution
As a consumer obtains more of good X, the amount of good Y the individual is willing to give up to obtain another unit of good X decreases.
Property 4- Transitivity: For any three bundles, , , and , either:
If and , then .
If and , then .
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4-4
Consumer Behavior
4
Constraints
While any decision-making environment faces a host of constraints, the focus of managerial economics is to examine the role prices and income play in constraining consumer behavior.
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4-5
Constraints
5
The Budget Constraint
Budget constraint
Restriction set by prices and income that limits bundles of goods affordable to consumers.
Budget set:
Budget line:
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4-6
Constraints
6
The Budget Constraint In Action
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4-7
Good
Good
0
Budget line:
Slope
Bundle G
Bundle H
Budget set:
Constraints
7
The Market Rate of Substitution
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4-8
Good
Good
0
Budget line:
Market rate of substitution :
Constraints
8
Changes in Income Shrink or Expand Opportunities
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4-9
Good
Good
0
Constraints
9
A Decrease in the Price of Good X
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4-10
Good
Good
0
New budget line
Initial budget
line
Constraints
10
The Budget Constraint in Action
Consider the following budget line:
What is the maximum amount of X that can be consumed?
What is the maximum amount of Y that can be consumed?
What is rate at which the market trades goods X and Y?
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4-11
Constraints
11
The Budget Constraint in Action
Answers:
Maximum X is: units
Maximum Y is: units
Market rate of substitution:
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4-12
Constraints
12
Consumer Equilibrium
Consumer equilibrium
Consumption bundle that is affordable and yields the greatest satisfaction to the consumer.
Consumption bundle where the rate a consumer choses (marginal rate of substitution) to trade between goods X and Y equals the rate at which these goods are traded in the market (market rate of substitution).
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4-13
Consumer Equilibrium
13
Consumer Equilibrium
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4-14
Good
Good
0
Consumer equilibrium
A
B
C
I
II
III
Consumer Equilibrium
D
14
Price Changes and Consumer Behavior
Price and income changes impact a consumer’s budget set and level of satisfaction that can be achieved.
This implies that price and income changes will lead to consumer equilibrium changes.
© 2017 by McGraw-Hill Education. All Rights Reserved.
4-15
Comparative Statics
15
Price Changes and Equilibrium
Price increases (decreases) reduce (expand) a consumer’s budget set.
The new consumer equilibrium resulting from a price change depends on consumer preferences:
Goods X and Y are:
substitutes when an increase (decrease) in the price of X leads to an increase (decrease) in the consumption of Y.
complements when an increase (decrease) in the price of X leads to a decrease (increase) in the consumption of Y.
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4-16
Comparative Statics
16
Price Changes and Equilibrium in Action
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4-17
Good
Good
0
Point A: Initial consumer equilibrium
Price of good X decreases:
A
B
Point B: New consumer equilibrium
I
II
Since when :
Conclude that goods and are
substitutes
Comparative Statics
17
Income Changes and Consumer Behavior
Income increases (decreases) reduce (expand) a consumer’s budget set.
The new consumer equilibrium resulting from an income change depends on consumer preferences:
Good X is:
a normal good when an increase (decrease) in income leads to an increase (decrease) in the consumption of X.
an inferior good when an increase (decrease) in income leads to a decrease (increase) in the consumption of X.
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4-18
Comparative Statics
18
Income Changes and Consumption
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4-19
Good
Good
0
A
B
II
I
Point A: Initial consumer equilibrium
Price of income increases:
Point B: New consumer equilibrium
Since more of both goods are consumed
when : Conclude that goods
and are normal goods.
Comparative Statics
19
Substitution and Income Effects
Moving from one equilibrium to another when the price of one good changes can be broken down into two effects:
Substitution effect: The movement along a given indifference curve that results from a change in the relative prices of goods, holding real income constant.
Income effect: The movement from one indifference curve to another that results from the change in real income caused by a price change.
© 2017 by McGraw-Hill Education. All Rights Reserved.
4-20
Comparative Statics
20
Substitution and Income Effects in Action
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4-21
Good
Good
0
Point A: Initial consumer equilibrium
Price of good X increases:
C
A
Point B: substitution effect
B
Point C: income effect and new
consumer equilibrium
Substitution
effect
Income
effect
Comparative Statics
I
G
H
F
J
21
Applications of Indifference Curve Analysis
Choices by consumers
Buy one, get one free
Cash gifts, in-kind gifts, and gift certificates
Choices by workers and managers
Income-leisure choice
Managers preferences
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22
Applications of Indifference Curves Analysis
Consumer Choice with a Gift Certificate
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4-23
Good X
0
Point A: Initial consumer equilibrium
Receive a $10 gift certificate for good :
A
Point B: higher utility holding
consumption at initial level
II
I
C
Point C: new consumer equilibrium
when and are normal
goods
B
Good Y
Applications of Indifference Curves
23
Labor-Leisure Choice Model
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4-24
0
E
I
Leisure
(hours per day)
Income
(per day)
16 hours of leisure
8 hours of work
Worker equilibrium
Applications of Indifference Curves
II
III
24
Labor-Leisure Budget Set in Action
What is the budget set for a worker who receives $5 per hour of work and a fixed payment of $40? Let denote the worker’s total earnings and the number of leisure hours in a 24-hour day.
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4-25
Applications of Indifference Curves
25
Indifference and Demand Curves
Indifference curves along with price changes determine individuals’ demand curves.
Market demand is the horizontal summation of individuals’ demands.
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4-26
The Relationship Between Indifference Curve Analysis and Demand Curves
26
From Indifference Curves to Individual Demand
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4-27
Good
Good
0
A
B
II
I
Good
Price of
good
Demand
The Relationship Between Indifference Curve Analysis and Demand Curves
27
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28
Good
0
A
Good
Price of
good
Demandmkt
Price of
good
B
A
B
A+B
DemandB
DemandA
From Individual to Market Demand
The Relationship Between Indifference Curve Analysis and Demand Curves
