david bryce © 1996-2002 adapted from baye © 2002 individual behavior manec 387 economics of...

David Bryce © 1996-2002Adapted from Baye © 2002


Individual BehaviorIndividual Behavior

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

David J. BryceDavid J. Bryce



The Structure of IndustriesThe Structure of Industries

Competitive Rivalry

Threat of newEntrants

BargainingPower of

Customers

Threat ofSubstitutes

BargainingPower of Suppliers

From M. Porter, 1979, “How Competitive Forces Shape Strategy”



“Can’t Get No Satisfaction”How Much Should I Consume?“Can’t Get No Satisfaction”How Much Should I Consume?

• Consumers maximize satisfaction

• Diminishing marginal return – next unit consumed gives less satisfaction than the last

• Consume until marginal satisfaction equals marginal cost

• Consumers maximize satisfaction

• Diminishing marginal return – next unit consumed gives less satisfaction than the last

• Consume until marginal satisfaction equals marginal cost

SatisfactionSatisfaction

ConsumptionConsumption

Cost = PcCCost = PcC

S*S*

C*C*

Tangency means MS=MCTangency means MS=MC



Consumer Behavior with Multiple GoodsConsumer Behavior with Multiple Goods

• Consumer Opportunities – the possible goods and services a 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 B– Prefers bundle B to bundle A: A B– Is indifferent between the two: A B

• Consumer Opportunities – the possible goods and services a 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 B– Prefers bundle B to bundle A: A B– Is indifferent between the two: A B



Consumer Preference OrderingConsumer Preference Ordering• Completeness – the consumer is capable of

expressing a preference for all bundles of goods

• More is better• Diminishing marginal rate of substitution• Transitivity

– Given 3 bundles of goods: A, B & C– If A B and B C, then A C– If A B and B C, then A C

• Completeness – the consumer is capable of expressing a preference for all bundles of goods

• More is better• Diminishing marginal rate of substitution• Transitivity

– Given 3 bundles of goods: A, B & C– If A B and B C, then A C– If A B and B C, then A C



Non-satiation – “more is better”Non-satiation – “more is better”



Indifference Curve AnalysisIndifference Curve Analysis

• Indifference Curve – a curve that defines the combinations of two or more goods that give a consumer the same level of satisfaction.

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

• Indifference Curve – a curve that defines the combinations of two or more goods that give a consumer the same level of satisfaction.

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

Good YGood Y

Good XGood X

S1S1

S2S2

S3S3

S3 > S2 > S1S3 > S2 > S1



From Satisfaction to IndifferenceFrom Satisfaction to Indifference

• Indifference curves are a 2-dimensional view of a 3-dimensional concept

• The satisfaction curve is a “mountain of happiness”

• Looking down from above “Mount Satisfaction,” the contour (elevation) lines are indifference curves.

• Indifference curves are a 2-dimensional view of a 3-dimensional concept

• The satisfaction curve is a “mountain of happiness”

• Looking down from above “Mount Satisfaction,” the contour (elevation) lines are indifference curves.

SatisfactionSatisfaction

XX

YY

XX

YYIrrationalRegion

IrrationalRegion



The Budget ConstraintThe Budget Constraint

• Opportunity set – the set of consumption bundles that are affordable

PxX + PyY M

• Budget line – the bundles of goods that exhaust a consumer’s income

PxX + PyY = M

• Market rate of substitution – the slope of the budget line

-Px / Py

• Opportunity set – the set of consumption bundles that are affordable

PxX + PyY M

• Budget line – the bundles of goods that exhaust a consumer’s income

PxX + PyY = M

• Market rate of substitution – the slope of the budget line

-Px / Py

YY

XX

Px

Py

Budget LineBudget Line

Opportunity SetOpportunity Set



Consumption DecisionConsumption Decision

• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.

• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.

Good YGood Y

Good XGood X

S1S1

S2S2

S3S3

X*X*

Y*Y*

ConsumptionBundle

ConsumptionBundle



Changes in the Budget ConstraintChanges in the Budget Constraint

• Changes in income– Increases lead to a

parallel, outward shift in the budget line

– Decreases lead to a parallel, downward shift

• Changes in price– A decreases in the price

of good X rotates the budget line counter-clockwise

– An increases rotates the budget line clockwise

• Changes in income– Increases lead to a

parallel, outward shift in the budget line

– Decreases lead to a parallel, downward shift

• Changes in price– A decreases in the price

of good X rotates the budget line counter-clockwise

– An increases rotates the budget line clockwise

XX

YY

XX

YY



Effect of Changing Income on Consumption Bundle Effect of Changing Income on Consumption Bundle

• Normal goods – good X is a normal good if an increase (decrease) in income leads to an increase (decrease) in its consumption.

• Inferior Goods – good X is a inferior good if an increase (decrease) in income leads to an decrease (increase) in its consumption.

• Normal goods – good X is a normal good if an increase (decrease) in income leads to an increase (decrease) in its consumption.

• Inferior Goods – good X is a inferior good if an increase (decrease) in income leads to an decrease (increase) in its consumption.



Normal GoodsNormal Goods

An increase in income increases the consumption of normal goods.

An increase in income increases the consumption of normal goods.

XX

YY

X1X1

Y1Y1

X2X2

Y2Y2



Decreasing Price Increases Quantity DemandedDecreasing Price Increases Quantity Demanded

• When the price of good X falls, the consumption of X rises – follows law of demand

• When the price of good X falls, the consumption of X rises – follows law of demand

XXX1X1

YY

X2X2

Y1Y1

Y2Y2



Individual Demand CurveIndividual Demand Curve

• An individual’s demand curve is derived from each new equilibrium point found on the indifference curve as the price of good X is varied.

• An individual’s demand curve is derived from each new equilibrium point found on the indifference curve as the price of good X is varied.

XX

YY

$$

XX

DD

P0P0

P1P1

X0X0 X1X1



Market DemandMarket Demand• The market demand curve is the horizontal

summation of individual demand curves.• It indicates the total quantity all consumers

would purchase at each price point.

• The market demand curve is the horizontal summation of individual demand curves.

• It indicates the total quantity all consumers would purchase at each price point.

QQ

$$ $$

QQ

5050

4040

D2D2D1D1

Individual Demand CurvesIndividual Demand Curves

Market Demand CurveMarket Demand Curve

1 2 1 2 1 2 3 1 2 3

DMDM

david bryce © 1996-2002 adapted from baye © 2002 individual behavior manec 387 economics of...

Documents

b slide

bundle b

b consumer opportunities

marginal satisfaction

satisfaction curve

bundles of goods

consumer behavior

consumer preferences