Download - Managerial Economics & Business Strategy
Managerial Economics & Business Strategy
Chapter 4The Theory of Individual
Behavior
Can we do it??
• On the next slide are schedules which show the total utility measured in terms of utiles which President
Strassburger would get by purchasing various amounts of product Apples, Bananas, Carrots, and Donuts.
Assume that the price of Bananas is $4, the price of Donuts is $18, the price of Apples is $1, the price of
Carrots is $6, and that President Strassburger’s income is $135. What quantities of Bananas, Donuts, Apples,
and Carrots will President Strassburger purchase?
Can you do it??B TU MU MU
/PD TU MU MU
/PA TU MU MU
/PC TU MU MU
/P
1 24 1 126 1 7 1 36
2 44 2 234 2 13 2 66
3 60 3 324 3 18 3 90
4 72 4 396 4 22 4 108
5 82 5 450 5 25 5 120
6 90 6 486 6 27.5 6 129
7 96 7 513 7 29 7 135
8 100 8 531 8 30 8 138
Can you do it??B TU MU MU
/PD TU MU MU
/PA TU MU MU
/PC TU MU MU
/P
1 24 --- 1 126 --- 1 7 --- 1 36 ---
2 44 20 2 234 108 2 13 6 2 66 30
3 60 16 3 324 90 3 18 5 3 90 24
4 72 12 4 396 72 4 22 4 4 108 18
5 82 10 5 450 54 5 25 3 5 120 12
6 90 8 6 486 36 6 27.5 2.5 6 129 9
7 96 6 7 513 27 7 29 1.5 7 135 6
8 100 4 8 531 18 8 30 1 8 138 3
Can you do it??B TU MU MU
/PD TU MU MU
/PA TU MU MU
/PC TU MU MU
/P
1 24 --- --- 1 126 --- --- 1 7 --- --- 1 36 --- ---
2 44 20 5 2 234 108 6 2 13 6 6 2 66 30 5
3 60 16 4 3 324 90 5 3 18 5 5 3 90 24 4
4 72 12 3 4 396 72 4 4 22 4 4 4 108 18 3
5 82 10 2.5 5 450 54 3 5 25 3 3 5 120 12 2
6 90 8 2 6 486 36 2 6 27.5 2.5 2.5 6 129 9 1.5
7 96 6 1.5 7 513 27 1.5 7 29 1.5 1.5 7 135 6 1
8 100 4 1 8 531 18 1 8 30 1 1 8 138 3 0.5
Can you do it??B TU MU MU
/PD TU MU MU
/PA TU MU MU
/PC TU MU MU
/P
1 24 --- --- 1 126 --- --- 1 7 --- --- 1 36 --- ---
2 44 20 5 2 234 108 6 2 13 6 6 2 66 30 5
3 60 16 4 3 324 90 5 3 18 5 5 3 90 24 4
4 72 12 3 4 396 72 4 4 22 4 4 4 108 18 3
5 82 10 2.5 5 450 54 3 5 25 3 3 5 120 12 2
6 90 8 2 6 486 36 2 6 27.5 2.5 2.5 6 129 9 1.5
7 96 6 1.5 7 513 27 1.5 7 29 1.5 1.5 7 135 6 1
8 100 4 1 8 531 18 1 8 30 1 1 8 138 3 0.5
Consumer Preference Ordering Properties
• Completeness Every individual can state their preferences NO “I don’t know”
• More is Better• Diminishing Marginal Rate of Substitution
As you get more good X the rate at which you are willing to substitute good X for good Y decreases
Have too much X don’t want more Shows indifference curves are CONVEX
• Transitivity If prefer A to B and B to C then prefer A to C IC cannot cross
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.
Marginal Rate of Substitution
The rate at which a consumer is willing to substitute one good for another and maintain the same satisfaction level.
Slope
I.
II.
III.
Good Y
Good X
Diminishing Marginal Rate of Substitution
• Marginal Rate of Substitution slope
• To go from consumption bundle A to B the consumer must give up 50 units of Y to get one additional unit of X.
• To go from consumption bundle B to C the consumer must give up 16.67 units of Y to get one additional unit of X.
• 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.
I.
II.
III.
Good Y
Good X1 3 42
100
50
33.33 25
A
B
CD
What was???
• The slope of the indifference curve?
Marginal rate of substitution
• MRS MRS = MUx/MUy
Along an indifference curve
yx MUYMUX **
y
x
MU
MU
X
Y
Doesn’t like risk!! STEEP indifference curveNeed BIG increase in return to give up a little risk
Likes risk!! FLAT Indifference CurveWill give up a lot of safety for a littleIncrease in return
The Budget Constraint• Opportunity Set
The set of consumption bundles that are affordable.
• PxX + PyY M.
• Budget Line The bundles of goods that exhaust a
consumers income.
• PxX + PyY = M.
• Market Rate of Substitution The slope of the budget line
• -Px / Py
Y
X
The Opportunity Set
Budget Line
Y = M/PY – (PX/PY)XM/PY
M/PX
Market Rate of Substitution
•
income
P
P
income
X
Y x
y
*
x
y
Pincome
Pincome
X
Y
y
x
P
P
X
Y
Changes in the Budget Line• Changes in Income
Increases lead to a parallel, outward shift in the budget line (M1 > M0).
Decreases lead to a parallel, downward shift (M2 < M0).
• Changes in Price A decreases in the price of
good X rotates the budget line counter-clockwise (PX0
> PX1).
An increases rotates the budget line clockwise
X
Y
X
YNew Budget Line for a price decrease.
M0/PY
M0/PX
M2/PY
M2/PX
M1/PY
M1/PX
M0/PY
M0/PX0M0/PX1
M2/PX2
New Budget Line for a price increase.
Consumer Equilibrium
• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.
Consumer equilibrium occurs at a point where
MRS = PX / PY.
Equivalently, the slope of the indifference curve equals the budget line.
I.
II.
III.
X
Y
Consumer Equilibrium
M/PY
M/PX