Individual Behavior
MANEC 387
Economics of Strategy
David J. Bryce
David Bryce © 1996-2002
Adapted from Baye © 2002
The Structure of Industries
Threat of new
Entrants
Bargaining
Power of
Suppliers
Competitive
Rivalry
Threat of
Substitutes
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David Bryce © 1996-2002
Adapted from Baye © 2002
Bargaining
Power of
Customers
“Can’t Get No Satisfaction”
How Much Should I Consume?
• Consumers maximize
satisfaction
• Diminishing marginal
return – next unit
Satisfaction
Cost = PcC
S*
consumed gives less
satisfaction than the last
• Consume until
marginal satisfaction
equals marginal cost
David Bryce © 1996-2002
Adapted from Baye © 2002
C*
Consumption
Tangency means MS=MC
Consumer 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:
– Prefers bundle B to bundle A:
– Is indifferent between the two:
David Bryce © 1996-2002
Adapted from Baye © 2002
AB
AB
AB
Consumer 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
David Bryce © 1996-2002
Adapted from Baye © 2002
Non-satiation – “more is better”
David Bryce © 1996-2002
Adapted from Baye © 2002
Indifference Curve Analysis
• Indifference Curve – a
curve that defines the
combinations of two or
more goods that give a
consumer the same level
of satisfaction.
Good Y
S3
S2
S1
• 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.
David Bryce © 1996-2002
Adapted from Baye © 2002
S3 > S2 > S1
Good X
From 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.
Satisfaction
Y
Y
X
Irrational
Region
X
David Bryce © 1996-2002
Adapted from Baye © 2002
The Budget Constraint
• Opportunity set – the set of
consumption bundles that are
affordable
Y
PxX + PyY  M
Opportunity Set
• 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
David Bryce © 1996-2002
Adapted from Baye © 2002
Budget Line
Px
Py
X
Consumption Decision
Good Y
• The equilibrium
consumption bundle
is the affordable
bundle that yields
the highest level of
satisfaction.
S3
S2
Consumption
Bundle
S1
Y*
X*
David Bryce © 1996-2002
Adapted from Baye © 2002
Good X
Changes in the Budget Constraint
• Changes in income
Y
– 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
David Bryce © 1996-2002
Adapted from Baye © 2002
X
Y
X
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.
David Bryce © 1996-2002
Adapted from Baye © 2002
Normal Goods
An increase
in income
increases the
consumption
of normal
goods.
Y
Y2
Y1
X1
David Bryce © 1996-2002
Adapted from Baye © 2002
X2
X
Decreasing Price Increases
Quantity Demanded
• When the
price of good
X falls, the
consumption
of X rises –
follows law
of demand
Y
Y1
Y2
X1
David Bryce © 1996-2002
Adapted from Baye © 2002
X2
X
Individual 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.
Y
X
$
P0
P1
D
X0 X1
David Bryce © 1996-2002
Adapted from Baye © 2002
X
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
David Bryce © 1996-2002
Adapted from Baye © 2002
DM
D2
Q
1 2 3
Q