Matakuliah : J0434/EKONOMI MANAJERIAL
Tahun
: 2008
The Theory of Individual Behavior
Pertemuan 7- 8
Managerial Economics & Business
Strategy
Chapter 4
The Theory of Individual Behavior
McGraw-Hill/Irwin
Michael
R. Baye, Managerial Economics and
Bina Nusantara
Business Strategy
Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
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
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4-4
4-5
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  B.
– Prefers bundle B to bundle A: A  B.
– Is indifferent between the two: A  B.
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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
Good Y
III.
II.
I.
– The rate at which a consumer is
willing to substitute one good for
another and maintain the same
satisfaction level.
Good X
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Consumer Preference Ordering Properties
•
•
•
•
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Completeness
More is Better
Diminishing Marginal Rate of Substitution
Transitivity
4-8
Complete Preferences
• Completeness Property
Good Y
– Consumer is capable of
expressing preferences (or
indifference) between all possible
bundles. (“I don’t know” is NOT an
option!)
I.
• 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.
III.
II.
A
B
C
Good X
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More Is Better!
• More Is Better Property
– Bundles that have at least as
much of 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 good
Y and strictly more of good X.
• Bundle B is also preferred to C
since B contains at least as much
of good X and strictly more of
good Y.
• More generally, all bundles on ICIII
are preferred to bundles on ICII or
ICI. And all bundles on ICII are
preferred to ICI.
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Good Y
III.
II.
I.
100
A
B
C
33.33
1
3
Good X
Diminishing Marginal Rate of Substitution
•
Marginal Rate of Substitution
–
–
•
•
•
4-10
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.
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 100
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
50
consumer must give up only 8.33 units of Y
to get one additional unit of X.
33.33
I.
A
B
C
D
25
1
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2
3
4
Good X
4-11
Consistent Bundle Orderings
• Transitivity Property
– For the three bundles A, B, and C, Good Y
the transitivity property implies
III.
that if C  B and B  A, then C 
II.
A.
– Transitive preferences along with
I.
the more-is-better property imply
A
100
that
• indifference curves will not
75
intersect.
• the consumer will not get caught
in a perpetual cycle of indecision.
B
50
1
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C
2
5
7 Good X
4-12
The Budget Constraint
• Opportunity Set
– The set of consumption bundles that
are affordable.
Y
Budget Line
• PxX + PyY  M.
• Budget Line
The Opportunity Set
M/PY
Y = M/PY – (PX/PY)X
– The bundles of goods that exhaust a
consumers income.
• PxX + PyY = M.
• Market Rate of Substitution
– The slope of the budget line
• -Px / Py
M/PX
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X
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Changes in the Budget Line
Y
• 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).
M1/PY
M0/PY
M2/PY
• 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 (not
shown).
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Y
M0/PY
M2/PX
M0/PX
M1/PX
X
New Budget Line for
a price decrease.
M0/PX0
M0/PX1
X
4-14
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.
Y
M/PY
Consumer
Equilibrium
III.
II.
I.
M/PX
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X
4-15
Price Changes and Consumer Equilibrium
• Substitute Goods
– An increase (decrease) in the price of good X leads to an
increase (decrease) in the consumption of good Y.
• Examples:
– Coke and Pepsi.
– Verizon Wireless or AT&T.
• Complementary Goods
– An increase (decrease) in the price of good X leads to a
decrease (increase) in the consumption of good Y.
• Examples:
– DVD and DVD players.
– Computer CPUs and monitors.
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Complementary Goods
When the price of
Pretzels (Y)
good X falls and the
consumption of Y
rises, then X and Y M/PY
1
are complementary
goods. (PX1 > PX2)
B
Y2
II
A
Y1
I
0
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X1 M/PX1
X2
M/PX2
Beer (X)
4-17
Income Changes and Consumer Equilibrium
• 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 an inferior good if an increase (decrease) in
income leads to a decrease (increase) in its consumption.
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Normal Goods
An increase in
income increases
the consumption of
normal goods.
Y
M1/Y
(M0 < M1).
B
Y1
M0/Y
A
Y0
I
0
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II
X0 M0/X
X1
M1/X
X
4-19
Decomposing the Income and Substitution Effects
Initially, bundle A is consumed.
A decrease in the price of good
X expands the consumer’s
opportunity set.
Y
C
The substitution effect (SE)
causes the consumer to move
from bundle A to B.
A
II
A higher “real income” allows
the consumer to achieve a
higher indifference curve.
The movement from bundle B to
C represents the income effect
(IE). The new equilibrium is
achieved at point C.
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B
I
0
IE
SE
X
4-20
A Classic Marketing Application
Other
goods
(Y)
A buy-one,
get-one free
pizza deal.
A
C
E
D
II
I
0
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0.5
1
2
B
F
Pizza
(X)
Individual Demand Curve
4-21
Y
• 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.
II
I
X
$
P0
D
P1
X0
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X1
X
4-22
Market 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.
$
Individual Demand
Curves
$
Market Demand Curve
50
40
D1
1 2
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D2
Q
1 2 3
DM
Q
4-23
Conclusion
• Indifference curve properties reveal information about consumers’
preferences between bundles of goods.
–
–
–
–
Completeness.
More is better.
Diminishing marginal rate of substitution.
Transitivity.
• Indifference curves along with price changes determine individuals’
demand curves.
• Market demand is the horizontal summation of individuals’ demands.
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