Chapter 4

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...