Managerial Economics & Business Strategy Chapter 4

Only available on StudyMode
  • Download(s): 280
  • Published: September 16, 2012
Read full document
Text Preview
Managerial Economics & Business Strategy Chapter 4
The Theory of Individual Behavior

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Overview
I. Consumer Behavior
Indifference Curve Analysis Consumer Preference Ordering

II. Constraints
The Budget Constraint Changes in Income Changes in Prices

III. Consumer Equilibrium IV. Indifference Curve Analysis & Demand Curves Individual Demand Market Demand
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Consumer Behavior
• Consumer Opportunities
The possible goods and services consumer can afford to consume.

• Consumer Preferences
The goods and services consumers actually consume.

• Given the choice between 2 bundles of goods a consumer either Prefers bundle A to bundle B: A f B. Prefers bundle B to bundle A: A p B. Is indifferent between the two: A ∼ B. Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Indifference Curve Analysis
Indifference Curve
A curve that defines the combinations of 2 or more goods that give a consumer the same level of satisfaction. Good Y III. II. I.

Marginal Rate of Substitution
The rate at which a consumer is willing to substitute one good for another and maintain the same satisfaction level.

Good X

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Consumer Preference Ordering Properties
• • • • Completeness More is Better Diminishing Marginal Rate of Substitution Transitivity

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Complete Preferences
• Completeness Property
Consumer is capable of expressing preferences (or indifference) between all possible bundles. (“I don’t know” is NOT an option!) • If the only bundles available to a consumer are A, B, and C, then the consumer – is indifferent between A and C (they are on the same indifference curve). – will prefer B to A. – will prefer B to C.

Good Y III. II. I.
A B

C

Good X

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

More Is Better!
• More Is Better Property
Bundles that have at least as much of Good Y every good and more of some good are preferred to other bundles. • Bundle B is preferred to A since B contains at least as much of I. good Y and strictly more of good X. • Bundle B is also preferred to C 100 since B contains at least as much of good X and strictly more of good Y. 33.33 • More generally, all bundles on ICIII are preferred to bundles on ICII or ICI. And all bundles on ICII are preferred to ICI.

III. II.

A

B

C

1

3

Good X

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Diminishing Marginal Rate of Substitution
• Marginal Rate of Substitution
The amount of good Y the consumer is willing to give up to maintain the same satisfaction level decreases as more of good X is acquired. The rate at which a consumer is willing to substitute one good for another and maintain the same satisfaction level.

Good Y III. II. I.
A

• •



To go from consumption bundle A to B the consumer must give up 50 units 100 of Y to get one additional unit of X. To go from consumption bundle B to C the consumer must give up 16.67 50 units of Y to get one additional unit of 33.33 X. 25 To go from consumption bundle C to D the consumer must give up only 8.33 units of Y to get one additional unit of X.

B C D

1

2

3

4

Good X

Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008

Consistent Bundle Orderings
• Transitivity Property
Good Y III. II. I.
A C B

For the three bundles A, B, and C, the transitivity property implies that if C f B and B f A, then...
tracking img