MANAGERIAL ECONOMICS
MODULE 1: FUNDAMENTALS
MANAGERIAL ECONOMICS
OF
Managerial Economics
 The study of how to direct scarce
resources in the way that most
efficiently achieves a managerial
goal.
 The key to making sound decisions is
to know what information is needed
to make an informed decision and
then to collect and process the data
 Resources are anything used to
produce a good or service, or
achieve a goal.
 Decisions are important because
scarcity implies trade-offs
Manager
 Directs resources and behavior of
individuals to achieve a stated goal.
 Has responsibility for his own actions
and the actions of individuals,
machines, and other inputs under the
manager’s control,
Effective Management
1. Identify Goals and Constraints
- The first step to making sound
decisions is to have well-defined
goals.
- Decision-makers
faces
constraints that affect the ability to
achieve a goal.
- Constraints are an artifact of
scarcity.
2. Recognize
the
Nature
and
importance of Profits
a. Accounting Profits
- Total amount of money taken in
from sales minus the dollar cost of
producing goods or services.
- Shows up in firm’s income
statement.
- Profits are a signal to resource
holders where resources are most
highly valued by society
- AP = Total Revenue – Explicit
Costs
b. Economic Profits
- Difference between total revenue
and opportunity cost.
-
Opportunity cost is the explicit
cost of a resource + the cost of
giving up its best alternative
Explicit cost – normal business
costs (wages, rent, and cost of
materials)
Implicit cost – a cost that already
occurred but not shown as a
separate expense (loss of interest,
foregone salary)
EP = Total Revenue – Opportunity
Costs
The Five Force Framework (Michael
Porter)
- Can be used to identify state of
competition and profitability of an
-
industry
A tool to help managers see the
big picture
1. Entry
- Heightens competition and
reduces the margins of
existing firms in a wide
variety of industry settings.
- Formation
of
new
companies,
globalization
strategies
by
foreign
companies, introduction of
new product lines by existing
firms.
2. Power of Input Suppliers
- Industry profits tend to be
lower when suppliers have
the power to negotiate
favorable terms for their
inputs.
3. Power of Buyers
- Industry profits tend to be
lower when customer or
buyers have the power to
negotiate favorable terms.
- Buyer concentration and
customer power are higher in
industries that serve high
volume customers
4. Industry Rivalry
- The sustainability of industry
profits also depends on the
nature and intensity of rivalry
among firms competing in
the industry.
- Rivalry is less intense in
concentrated industries
5. Substitutes
and
Complements
- Presence of close substitutes
erodes industry profitability
3. Understanding Incentives
- Incentives affect how resources
are used and how hard workers
work.
- As a manager, you must have a
clear grasp of the role of
incentives within an organization
and how to construct incentives to
induce maximal effort from those
you manage.
- Individuals are often motivated by
self-interest
4. Understanding Markets
- For every buyer of a good, there is
a corresponding seller
- The power or bargaining position
of consumers and producers are
limited by 3 sources of rivalry that
exist in economic transactions:
a. Consumer-Producer Rivalry
- Consumers attempt to
negotiate low prices;
Producers attempt to
negotiate high prices.
Consumers
and
producers attempt to ripoff each other.
b. Consumer-Consumer
Rivalry
- Arises
because
of
scarcity;
consumers
compete with each other
for the right to purchase
the available goods
c. Producer-Producer Rivalry
-
-
Only when multiple sellers
of a product compete in
the
marketplace;
producers compete with
one another for the right to
service customers
The firms that offers the
best quality product at the
lowest price earn the right
to serve the customers
d. Government and the Market
- When both producers and
consumers
find
themselves
disadvantaged in the
market process, they
attempt
to
induce
government to intervene
on their behalf; gov’t
disciplines
market
process
5. Recognize the Time Value of
Money
- The fact that $1 today is worth
more than $1 received in the
future
- The opportunity cost reflects the
time value of money
Present Value Analysis
- Amount that would have to be
invested today at the prevailing
interest rate to generate the given
future value.
1. Present Value of a Single Value
- The higher the interest rate, the
lower the present value of a future
amount and conversely.
- The present value of a future
payment reflects the difference
between the FV and OCW :
- PV = FV = OCW
- The higher the interest rate, the
higher the OCW to receive a
future amount, the lower the
present value of the future amount
- PV = FV when interest rate is 0%
2. Present Value of a Stream of
Future Values
- Present value of a future amount
extended to a series of future
payments
3. Net Present Value of a Project
- PV of the income stream
generated by the project minus
the current cost of the project
- If the NPV of a project is positive,
it is profitable because the present
value of the earnings from the
project exceeds the current cost of
project.
- If the NPV is negative, it should be
rejected because the cost
exceeds the present value of the
income stream the project
generates.
4. Present Value of Indefinitely
Lived Assets
- Some decisions generate cash
flows that continue indefinitely
- Consider an asset that generates
a cash flow from one to three
-
years for an indefinite period of
time
The asset generates a perpetual
stream of identical cash flows at
the end of
each
period
5. Present Value of a Firm
- The value of the firm today is the
present value of its current and
future profits
- Profit
Maximization
means
maximizing the value of the firm,
which is the present value of the
current and future profits.
- Maximizing Short-term profits may
maximize long-term profits. If the
growth rate in profits is less than
the interest rate and both are
constant, maximizing current
profits is the same as maximizing
long term profits.
6. Marginal Analysis
- Optimal managerial decisions
involve comparing the managerial
benefits of a decision with the
marginal costs
- Marginal
Benefits
are
the
additional benefits that arise by
using an additional unit of
managerial cost variable.
- Marginal Costs are costs incurred
by using additional unit of the
managerial cost variable.
- Marginal Net Benefits of Q,
MNB(Q), are the change in net
benefits that arise from one unit
change in Q.
- Marginal Principle: to maximize
net benefits, the manager should
increase the managerial control
-
-
variable up to the point where
marginal benefits = marginal
costs.
B(Q) = Benefits C(Q) = Costs
Manager’s objective to maximize
net benefits: N(Q)= B(Q)-C(Q)
MNB (Q) = MB(Q)-MC(Q)
Choosing one option may mean
you lose money because you
turned down another alternative.
These incremental costs are
called opportunity costs.
Incremental Cost/Revenues are
additional cost/revenues that stem
from a yes/no decision.
MODULE 2: MARKET FORCES:
SUPPLY AND DEMAND
current purchases for
purchases by stockpiling.
future
A. Demand
 The Law of Demand states that the
price and quantity demanded are
inversely related
+ P - QD, - P + QD
 Market Demand Curve. A curve
indicating the total quantity of a good
all consumers are willing and able to
purchase at each possible price,
holding all variables constant
Consumer Surplus
 The value consumers get from a good
but do not pay extra for.
 It shows manager how much extra
money consumers would be willing to
pay for a given amount of purchased
product
 It is the area above the price paid but
below the demand curve
Demand Shifters
 Change in Quantity Demanded. Is a
movement along the demand curve.
Rightward shift is a demand increase
Leftward shift is a demand decrease
B. Supply
 The Law of Supply states that that
the price and quantity supplied are
directly related
+ P +QS, -P -QS
 Market Supply Curve. a curve
indicating the total quantity of a good
that all producers in a competitive
market would produce at each price,
holding all variables constant.
1. Income
- A change in income shifts the
entire demand curve.
- Normal goods demand increases
when income increases ( + I + NG,
- I - NG)
- Inferior goods demand increases
when income decreases ( - I +SG,
+I -SG)
2. Price of Related Goods
- Shift the demand curve for a good
- Substitutes are goods which a
price increase (decrease) in one
good leads to a demand increase
(decrease) for another.
- Complements are goods which a
price
increase
(decrease) in one good leads to a
decrease (increase) in the other.
3. Advertising and Consumer
Taste
- An increase in advertising shifts
the demand curve to the right
- Informative advertising provides
information about product
- Persuasive Advertising alters the
underlying taste of consumers by
making them perceive it as “the
thing” to buy.
4. Population
- Population increases the market
- Shifts the demand curve to the
right
5. Consumer Expectations
- If consumers expect future prices
to be higher, they will substitute
Supply Shifters
 Change in Quantity Supplied. A
movement along the supply curve
wherein:
Rightward shift is a supply increase
Leftward shift is a supply decrease
1. Input Prices
- As production costs change, the
willingness of producers to
produce output changes ( +IP QS, -IP +QS)
2. Technology or Government
Regulations
- Changes that reduce production
cost like technology increase
quantity supplied
3. Number of Firms
- As more firms enter an industry,
more output are available at each
given price
4. Substitutes in Production
- Many firms have technologies that
are readily adaptable to several
different products
5. Taxes
- Excise tax. Is a tax on each unit of
output sold, where the tax revenue
is collected by the supplier; it
decreases the supply for a good
- Ad valorem tax. Means according
to the value. It is a percentage tax.
An ad valorem tax will rotate the
supply curve counterclockwise.
6. Producer Expectations
- If firms suddenly expect prices to
be higher in the future and the
product is not perishable, products
can be held back from being sold
to be able to sell it at a higher price
in the future.
Producer Surplus
 Amount producers receive in
excess of the amount necessary to
induce them to produce a good.
 Area above the supply curve but
below the market price of the good.
Market Equilibrium
 The equilibrium price in a competitive
market is determined by interactions of
all buyers and sellers in the market
 Equilibrium Price and Equilibrium
Quantity wherein there is no shortage
or surplus.
 In situations where shortage exists,
there is a natural tendency for prices
to rise; consumers unable to buy the
good may offer a higher price to get
the product
 In situations where surplus exists,
producers are producing more than
they can sell. There is a natural
tendency for the prices to fall to sell
unsold inventories.
Price Ceiling
 The highest permissible price of a
good in the market; reduces the
quantity available in the market and
reduces social welfare
 Full economic price. The dollar
amount paid to affirm under a price
ceiling, plus the non-pecuniary price.
 Non-pecuniary price is price paid by
opportunity cost
 Pf = Pc + (Pf – Pc)
Full economic price = Dollar Price +
non-pecuniary price
Price Floor
 The minimum legal price that can be
charged in a market
 More is produced than consumers are
willing to purchase at that price. Thus,
surplus is produced.
 In labor market, more people look for
work than there are jobs which result
in unemployment
 When price floors are above the
equilibrium price, there will be
consumers willing to pay more than
production costs but less than the
price floor. These consumers will be
unable to purchase when price floor is
placed, which results in loss of social
welfare.
 Price support is a price floor wherein
the government purchases the surplus
products
 A deadweight loss is a cost to society
created by market inefficiency, which
occurs when supply and demand are
out of equilibrium; can be applied to
any deficiency caused by an inefficient
allocation of resources.
 When a price floor applies to a
product, deadweight loss is greater.
Additional deadweight loss when
surplus products purchased are
discarded.
MODULE 3: QUANTITATIVE DEMAND
ANALYSIS
Elasticity
Measures how the amount of
good changes when its price goes up or
down; responsiveness of one variable to
changes in another variable.
It is how quick consumers react to
changes
in
price;
pertains
to
responsiveness.
=%△Q =Q2 – Q1
%△P _____Q1_____
P2 – P1
P1
Demand is elastic when
absolute value of the own price
elasticity is greater than 1.
P
Q
Inelastic Demand ( < 1 )
More changes in price than
demand; the absolute value of the
own price elasticity is less than 1.
When demand is inelastic,
a price increase will reduce
consumption very little.
P
If the elasticity is positive, an
increase in Price (P), leads to an increase
in Quantity (Q).
If the elasticity is negative, an
increase in Price (P) leads to a decrease
in Quantity (Q).
If the absolute value of the
elasticity is greater than 1, a small
percentage change in Price (P) will lead
to a relatively large percentage change in
Quantity (Q).
Q
Unitary Elastic ( =1 )
The absolute value of the
own price elasticity is equal 1.
Changes in demand = Changes in
price
P
Q
If the absolute value of the
elasticity is less than 1, a percentage
change in Price (P) will lead to a relatively
small percentage change in Quantity (Q).
Perfectly Elastic
The own price elasticity of
demand is infinite in absolute
value.
Own Price Elasticity of Demand
Measures the responsiveness of
quantity demanded to change in price.
There is a change in
demand but no change in price. A
slight increase in price will result to
a drastic decrease in QD.
=%△Qxd
%△Px
Elastic Demand ( > 1 )
Consumers are responsive
to the product; more changes in
demand than price.
When demand is elastic, a
price
increase
will
reduce
consumption considerably.
P
Q
Perfectly Inelastic
The own price elasticity of
demand is 0.
Same quantity demanded
at different price levels. An
increase in price does not affect
the QD.
Total revenue is maximized at the
point where demand is unitary elastic.
P
Q
Factors Affecting the Own Price
Elasticity:
1. Available Substitutes – the
more substitutes available for
the good, the more elastic the
demand for it. When there are
few close substitutes for a
good, demand tends to be
relatively inelastic.
2. Time/duration of purchase
horizon – time to search for
more alternative products. The
more time consumers have to
react to a price change, the
more elastic the demand for a
good,
3. Expenditure share – when a
good comprises only a small
portion of the budget, the
consumer can reduce the
consumption of other goods
when the price of the good
increases.
Marginal Revenue and the Own Price
Elasticity of Demand
Marginal Revenue is the change
in total revenue due to a change in
output. To maximize profit, marginal
revenue must equal to marginal cost.
To induce consumers to purchase
more of a good, a firm must lower its
price.
Total Revenue Test
The relationship among the
changes in price, elasticity, and total
revenue.
If demand is elastic, an increase
(decrease) in price will lead to a decrease
(increase) in total revenue.
If demand is inelastic, an increase
(decrease) in price will lead to an
increase (decrease) in total revenue,
Cross-Price Elasticity
The responsiveness of the
demand for a good to changes in price of
a related good.
The percentage change in the
quantity demanded of one good divided
by the percentage change in the price of
a related good.
=%△Qxd
%△Py
When goods X and Y are
substitutes, an increase in the price of Y
leads to an increase in demand for X
(E>0)
When goods X and Y are
complements, an increase in the price of
Y leads to a decrease in demand for X
(E<0)
Assessing the overall change in
revenue from a price change for one
good when a firm sells to goods is:
Change in revenue =
[Revenue for Good X (1 + Own Price
Elasticity) + Revenue for Good Y
(Cross-Price Elasticity)] (% change in
the Price of X)
Income Elasticity
A measure of the responsiveness
of consumer demand to changes in
income.
E =%△Qxd
%△M
When good X is a normal good, an
increase in income leads to an increase
in the consumption of X. (E>0)
When good X is an inferior good,
an increase in income leads to decrease
in the consumption of X. (E<0)
Other Elasticities:
Own advertising and cross-advertising
elasticity of demand. An increase in
advertising will lead to an increase in the
demand for the products.
Elasticities for Non-Linear Demand
Functions
There are situations wherein a
product’s demand is not a linear function
of prices, income, advertising, and other
demand shifters.
A linear demand is log linear (ln)
if the logarithm of demand is a linear
function of the logarithm of prices,
income, and other variables.
Regression Line
is the line that minimizes the squared
deviations between the line and the actual
data points.
Least Squares regression line
a’ = least squares estimate of the unknown
parameter a
b’ = least squares estimate of the unknown
parameter b
Coefficients - a0, a1, a2.
Additional insights except intercept(a0)
Positive means an independent
variable has a direct relationship to the
dependent variable, negative means inverse
relationship with the dependent variable
Parameter estimates
the values that represent a and b that
result in the smallest sum of squared errors
between a line and the actual data.
Example:
Demand for raincoats:
Ln Qxd = 10 – 1.2ln Px + 3ln R – 2ln Ay
R = daily amount of rainfall
Ay = level of advertising on Good Y
The impact of a 10% increase in daily
amount of rainfall on demand:
E = BR = 3
E = % Change in Qxd
%Change in R
3 = % Change in Qxd = 30
10
T-stat
The ratio of the value of the
parameter estimate to its standard error.
Rule of thumb. If the absolute value is
greater than or equal to 2, then we are 95%
confident that the coefficient in the
regression is not 0.
A 10% increase in rainfall will lead to a 30%
increase in the demand for raincoats.
Regression Analysis
The regression analysis assumes
that the manager knows the demand for the
firm’s product.
Econometrics is
analysis of economic data.
Standard error
a measure of how much each
estimated coefficient would vary in
regressions based on the same underlying
true demand relation, but with different
observations; the mean of all absolute values
of errors.
the
statistical
True (Population) Regression Model
Y = a + bX + e
a = unknown population intercept
parameter
b = unknown population slope
parameter
e = random error term with mean zero
and standard deviation
P value
If the P value is less than or equal to
0.05, then the estimated coefficient is
statistically significant at 5% level.
F-stat
Provides a measure of the total
variation explained by the regression relative
to the total unexplained variation.
the greater the value, the better the
overall regression fit. The regression
function, y=â+b^x bc, is almost the same as
the true regression model, y = a+bx+e.
Significance F
Same interpretation as P value but as
a whole. If the significance f is less than or
equal to 0.05, then the estimated regression
model is statistically significant at 0.05
confidence level.
R (Coefficient of Correlation)
strong negative, negative, positive,
strong positive relationship between the
variables.
R^2 (Coefficient of Determination)
Provides diagnostics that indicate
how well the regression line explains the
sample of observations of the dependent
variable.
It is the percentage of variation
explained by the regression line but it is a
subjective measure of goodness of fit.
The greater the value, (closer to
100% or to 1), the closer the regression
model is to the actual data.
Adjusted R^2
R^2 is adjusted when there are
discrepancies in its percentage value. This
penalizes the researcher for performing a
regression with only a few degrees of
freedom. The penalty can be so high that in
some cases the adjusted r^2 is negative.
= 1 – (1-R^2) (n-1)
n-k
n = total number of observations
k = number of estimated coefficients
(n-k) = residual degrees of freedom
MODULE 4: THEORY OF INDIVIDUAL
BEHAVIOR
CONSUMER BEHAVIOR
Consumers
An individual who purchases
goods and services from firms for the
purpose of consumption.
1. Consumer Opportunities set of
possible
goods
and
services
consumers can afford to consume
2. Consumer Preferences determine
which of sets of goods and services
will be consumed
Property 1: Completeness
Implies that a bundle of goods can be
ranked as preferred, indifferent, or
less preferred to one another.
A>B
B>A
A~B
Indifference curve
Shows the combination of goods
X and Y that gives the consumer the
same level of satisfaction. The consumer
is indifferent between any combination of
goods along an indifference curve.
The shape depends on consumer
preference.
A shift of the indifference curve to
the right(left) is an increase(decrease) in
the satisfaction on the consumption of
Goods X and Y.
Marginal Rate of Substitution (MRS)
It is the amount of good Y a
consumer is willing to give up for good X
and still lie on the same indifference
curve.
It is the absolute value of the slope
of an indifference curve.
CONSTRAINTS
Property 2: More is Better
The consumer views the products
under consideration as
“goods”
instead of bads. If bundle A has at
least as much of every good as
bundle B and more of some good,
bundle A is preferred to bundle B.
Property 3: Diminishing Marginal
Rate of Substitution
As consumer obtains more of good
X, the amount of good Y the
consumer is willing to give up to
obtain another unit of good X
decreases; Indifference curve is
convex from the origin.
Property 4: Transitivity
The
assumption
of
transitive
preferences, together with the moreis better assumption, implies that
indifference curves do not intersect
one another.
It eliminates the possibility that the
consumer is caught in a perpetual
cycle in which he never makes a
choice.
If A>B and B>C then A>C
If A~B and B~C then A~C
The Budget Constrains
Is a restriction set by prices and income
that limits bundles of goods affordable to
consumers. It restricts consumer
behavior by forcing the consumer to
select a bundle of goods that is
affordable.
M – income
Px Py – Prices of Goods X and Y
Budget Set are the bundles of goods the
consumer can afford; also called
opportunity set
PxX + PyY < M
Budget Line are the bundles of goods
that exhaust a consumer’s income
PxX + PyY = M
Slope intercept form:
Px X + Y = M
Py
Py
Y = M – Px X
Py Py
Vertical intercept is the maximum
amount of good Y that can be
consumed.
M/Py
Horizontal
intercept
is
the
maximum amount of good X that
can be consumed.
M/Px
Market Rate of Substitution is the rate
at which one good may be traded for
another in the market
COMPARATIVE STATICS
Price
Changes
and
Consumer
Behavior
Price and income changes impact
a consumer’s budget set and level of
satisfaction that can be achieved, which
will lead to consumer equilibrium
changes.
Price Changes and Equilibrium
Price
increases
(decreases)
reduce (expand) a consumer’s budget
set.
Slope:
-Px/Py
Changes in Income
Increase in income will not affect
the slope of the budget line
The new consumer equilibrium
resulting from a price change depends on
consumer preferences:
The vertical and horizontal
intercept both increase as the consumers
income increases because more of each
good can be purchased at a higher
income. When income increases budget
line shifts to the right.
Goods x and y are substitutes
when an increase (decrease) in the price
of X leads to an increase (decrease) in
the consumption of Y.
Changes in Prices
Holding income constant, a
reduction in price of good X will rotate the
budget line counterclockwise an increase
in good x leads to a clockwise rotation of
the budget line
Consumer Equilibrium
Consumption bundle
affordable and yields the
satisfaction to the consumer.
that is
greatest
The rate a consumer chooses
(marginal rate of substitution), to trade
between goods X and Y, equals the rate
at which these goods are traded in the
market (market rate of substitution)
Equilibrium refers to the fact that
the consumer has no incentive to change
to a f=different affordable bundle one’s
this point is reached.
MRS = Px
Py
Goods x and y are complements
when an increase (decrease) in the price
of X leads to a decrease (increase) in the
consumption of Y.
Income Changes and Consumer
Behavior
Income increases (decreases),
reduce (expand) a consumer’s budget
set.
The new consumer equilibrium
resulting from an income change
depends on consumer preferences:
Good X is a normal good when
an increase (decrease) in income leads
to an increase (decrease) in the
consumption of X
Good X is an inferior good when
an increase (decrease) in income leads
to an decrease (increase) in the
consumption of X
Substitution and Income Effects
A lower “real income” will be
achieved, as a lower indifference is all
that can be achieved after a price
increase.
Moving from one equilibrium to
another when the price of one good
changes can be broken down into:
Substitution
effect
the
movement along a given indifference
curve that results from a change in the
relative price of goods, holding real
income
constant.
Reduction
in
consumption of x implies higher market
rate of substitution.
Income effect the movement
from one indifference curve to another
(parallel shift in the budget line) that
results from the change in real income
caused by a price change. When price
increases, real income falls.
Labor-Leisure Choice Model
Workers view both leisure and
income and goods and substitutes
between them at a diminishing marginal
rate; when workers enjoy leisure, they
also enjoy income.
A typical workers indifference
curve has the usual shape where we
measure the quantity of leisure and
income consumed by an employee.
To induce workers to give up
leisure, firms must compensate them.
E = fixed rate + hourly rate (number of
work hours – number of leisure hours)
Relationship between Indifference
Curve Analysis and Demand Curves
Indifference curves along with
price changes determine individuals’
demand curves
Market demand is the horizontal
summation of individuals demands. It
indicates the total quantity all consumers
in the market would purchase at each
possible price.
 Maximizing total benefits results in
maximizing net benefits when costs are
zero
 The minimum wage is an example of
price floor
 Marginal Net Benefits are the change in
net benefits that arise from a one-unit
change in quantity
 Incremental Revenues are additional
revenues derived from a decision.
 The law of demand states that price and
quantity demanded are inversely
related
 An increasing in the price of steak will
probably lead to an increase in demand
for chicken
 An ad valorem tax shifts the supply
curve by rotating it counterclockwise
 Additional costs will exceed additional
revenues when a firm is producing the
output at which its profit is maximized
 If substitute products are available on
the market, buyer power is high.
 Other things held constant, the greater
the price of a good, the lower the
consumer surplus
 Consumer-consumer rivalry is due to
the economic doctrine of scarcity
 According to Michael Porter, the
competitive force of entry heightens
competition and reduces the margins of
existing firms in a wide variety of
industry settings
 The equilibrium quantity of lettuce will
rise due to unseasonably cold weather,
and supply has substantially decreased
 Profits are a signal to resource holders
where resources are most highly valued
by society
 Economic profit is the difference
between total revenue and opportunity
costs
 If consumers expect future prices to be
higher, stockpiling will happen when
products are durable
 When dealing with present value, a
higher interest rate decreases the
present value of a future amount
 Wages, rent, and cost of materials are
examples of explicit costs
 If an excise tax is imposed on a good,
then the supply curve shifts up by the
amount of tax.
 If price is above equilibrium level,
competition among sellers to reduce;
surplus
will
increase
quantity
demanded and decrease quantity
supplied.
 Based on the principles of effective
management, the first step in making
sound decision is to identify goals and
constraints
 For a steel factory, a decrease in the
cost of electricity to the plant will cause
the supply curve to become parallel to
the price axis
 Suppose the demand for good X is Qdx
= 10 +axPx + ayPy + aMm. If aM is
negative, then good y is an inferior
good.
 Good X is a normal good, its demand is
given by Qxd = a0 + axPx + ayPy +
aMm + aHh. Then we know that aM > 0
 Competitive market equilibrium is
determined by the intersection of the
market demand and supply curves
 Producer surplus is measured as the
area above the supply curve and below
the market price
 Suppose the demand function is given
by Qxd = 8Px 0.5Py 0.25M 0.12H, then
the demand for good X is elastic
(perfectly elastic)
 The property that rules out indifference
curves that cross is transitivity
 Consumer preferences and consumer
opportunities are the important things
that must be developed when
characterizing consumer behavior
 The property of completeness is
violated in a situation where a
consumer says he does not know his
preference ordering for bundles X and
Y
 As we move down along a linear
demand curve, the price elasticity of
demand becomes more inelastic
(loglinear/variable)
 The idea that a consumer is limited to
selecting a bundle of goods that is
affordable is captured by the Budget
Constraint
 The quantity consumed of a good is
relatively unresponsive to changes in
price whenever demand is inelastic
 The F tests provide information about
the overall statistical significance of the
regression model
 Income effect is the movement from
one indifference curve to another that
results from a change in real income
caused by a price change
 The budget line will shift inward if a
consumer’s income decreases
 The absolute value of the slope of the
indifference curve is the Marginal Rate
of Substitution
 A price elasticity of zero corresponds
to a demand curve that is vertical.
 M/Px is the horizontal intercept of the
budget line
 If apples have an own price elasticity of
-1.2 we know that demand is elastic
 The more is better property is violated
when a three-pack soda is preferred to
a six-pack.
 Qxd = 8Px 0.5Py 0.25M 0.12 H, Then
good x is a normal good
 The combinations of goods X and Y
that are affordable to the consumer are
defined by the budget set
 The movement along a given
indifference curve that results from a
change in the relative prices of goods,
holding real income constant is called
the substitution effect
 Managers can get workers to work
longer hours by offering overtime pay
 Holding others constant, A decrease in
consumer’s income will cause an
inward shift in the budget line because
the consumer can now purchase less
of both products
 Assume the price elasticity of demand
is given as -2, if the firm raises price,
the firm’s managers can expect total
revenues to remain constant or
increase, depending on the size of
price increase.
 Assume that good X is a normal good,
and good Y is an inferior good. If
income is halved, and all prices
double, consumption of good X will
decrease and consumption of good Y
will increase.
 Qxd = 8Px 0.5Py 0.25M 0.12 H, Then
the cross-price elasticity between
goods x and y is 0.25
 An increase in income does not affect
the slope of the budget line, while a
decrease in price changes the slope.
 The statistical analysis of an economic
phenomena is called econometrics