Managerial EconomicsCopyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin Managerial Economics, 9e
Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin Managerial Economics, 9e
The Consumer’s Optimization Problem
Individual consumption decisions are made with the goal of maximizing total satisfaction from consuming various goods and services
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Range of products available
Prices of all products
Their income
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Completeness
For every pair of consumption bundles, A and B, the consumer can say one of the following:
A is preferred to B
B is preferred to A
The consumer is indifferent between A and B
Transitivity
If A is preferred to B, and B is preferred to C, then A must be preferred to C
Nonsatiation
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Benefits consumers obtain from goods & services they consume is utility
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Indifference Curves
Locus of points representing different bundles of goods, each of which yields the same level of total utility
Negatively sloped & convex
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Marginal Rate of Substitution
MRS shows the rate at which one good can be substituted for another while keeping utility constant
Negative of the slope of the indifference curve
Diminishes along the indifference curve as X increases & Y decreases
Ratio of the marginal utilities of the goods
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Quantity of good X
Quantity of good Y
Marginal Utility
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Consumer’s Budget Line
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Price of X = $5, Y = $10
5-*
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Quantity of Y
Quantity of X
Quantity of Y
Quantity of X
Quantity of Y
Quantity of X
200
100
A
B
250
D
R
N
120
240
F
Z
80
160
125
C
Utility Maximization
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Utility Maximization
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Quantity of burgers
Quantity of pizzas
Individual Consumer Demand
An individual’s demand curve for a specific commodity relates utility-maximizing quantities purchased to market prices
Money income & prices held constant
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Quantity of Y
Price of X ($)
Quantity of X
Quantity of X
Market Demand & Marginal Benefit
List of prices & quantities consumers are willing & able to purchase at each price, all else constant
Derived by horizontally summing demand curves for all individuals in market
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$6
2
1
5
4
3
3
25
31
6
12
19
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Substitution & Income Effects
When price changes, total change in quantity demanded is composed of two parts
Substitution effect
Income effect
Substitution effect
Change in consumption of a good after a change in its price, when the consumer is forced by a change in money income to consume at some point on the original indifference curve
Income effect
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Total effect of price decrease
=
=
Amount of good consumed must vary inversely with price
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X rises
X rises
X rises
X rises
X falls
X falls
X falls
X falls
Substitution Effect
Income Effect