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Transcript of David Bryce © 1996-2002 Adapted from Baye © 2002 Individual Behavior MANEC 387 Economics of...
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Individual BehaviorIndividual Behavior
MANEC 387MANEC 387
Economics of StrategyEconomics of Strategy
MANEC 387MANEC 387
Economics of StrategyEconomics of Strategy
David J. BryceDavid J. Bryce
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
The Structure of IndustriesThe Structure of Industries
Competitive Rivalry
Threat of newEntrants
BargainingPower of
Customers
Threat ofSubstitutes
BargainingPower of Suppliers
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
“Can’t Get No Satisfaction”How Much Should I Consume?“Can’t Get No Satisfaction”How Much Should I Consume?
• Consumers maximize satisfaction
• Diminishing marginal return – next unit consumed gives less satisfaction than the last
• Consume until marginal satisfaction equals marginal cost
• Consumers maximize satisfaction
• Diminishing marginal return – next unit consumed gives less satisfaction than the last
• Consume until marginal satisfaction equals marginal cost
SatisfactionSatisfaction
ConsumptionConsumption
Cost = PcCCost = PcC
S*S*
C*C*
Tangency means MS=MCTangency means MS=MC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Consumer Behavior with Multiple GoodsConsumer 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: A B– Prefers bundle B to bundle A: A B– Is indifferent between the two: A B
• 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: A B– Prefers bundle B to bundle A: A B– Is indifferent between the two: A B
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Consumer Preference OrderingConsumer 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
• 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 © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Non-satiation – “more is better”Non-satiation – “more is better”
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Indifference Curve AnalysisIndifference Curve Analysis
• Indifference Curve – a curve that defines the combinations of two 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 stay at the same satisfaction level.
• Indifference Curve – a curve that defines the combinations of two 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 stay at the same satisfaction level.
Good YGood Y
Good XGood X
S1S1
S2S2
S3S3
S3 > S2 > S1S3 > S2 > S1
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
From Satisfaction to IndifferenceFrom 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.
• 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.
SatisfactionSatisfaction
XX
YY
XX
YYIrrationalRegion
IrrationalRegion
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
The Budget ConstraintThe Budget Constraint
• Opportunity set – the set of consumption bundles that are affordable
PxX + PyY M
• 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
• Opportunity set – the set of consumption bundles that are affordable
PxX + PyY M
• 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
YY
XX
Px
Py
Budget LineBudget Line
Opportunity SetOpportunity Set
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Consumption DecisionConsumption Decision
• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.
• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.
Good YGood Y
Good XGood X
S1S1
S2S2
S3S3
X*X*
Y*Y*
ConsumptionBundle
ConsumptionBundle
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Changes in the Budget ConstraintChanges in the Budget Constraint
• Changes in income– 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
• Changes in income– 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
XX
YY
XX
YY
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Effect of Changing Income on Consumption Bundle 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.
• 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 © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Normal GoodsNormal Goods
An increase in income increases the consumption of normal goods.
An increase in income increases the consumption of normal goods.
XX
YY
X1X1
Y1Y1
X2X2
Y2Y2
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Decreasing Price Increases Quantity DemandedDecreasing Price Increases Quantity Demanded
• When the price of good X falls, the consumption of X rises – follows law of demand
• When the price of good X falls, the consumption of X rises – follows law of demand
XXX1X1
YY
X2X2
Y1Y1
Y2Y2
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Individual Demand CurveIndividual 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.
• 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.
XX
YY
$$
XX
DD
P0P0
P1P1
X0X0 X1X1
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Market DemandMarket Demand• The market demand curve is the horizontal
summation of individual demand curves.• It indicates the total quantity all consumers
would purchase at each price point.
• The market demand curve is the horizontal summation of individual demand curves.
• It indicates the total quantity all consumers would purchase at each price point.
$$ $$
5050
4040
D2D2D1D1
Individual Demand CurvesIndividual Demand Curves
Market Demand CurveMarket Demand Curve
1 2 1 2 1 2 3 1 2 3
DMDM