MANAGERIAL MANAGERIAL ECONOMICS 11ECONOMICS 11thth Edition Edition

ByBy

Mark HirscheyMark Hirschey

Consumer DemandConsumer Demand

Chapter 4Chapter 4

Chapter 4Chapter 4OVERVIEWOVERVIEW

Utility Theory Indifference Curves Budget Constraints Individual Demand Demand Curves and Consumer Surplus Consumer Choice Optimal Consumption

Chapter 4Chapter 4KEY CONCEPTSKEY CONCEPTS

utility nonsatiation principle indifference ordinal utility cardinal utility utility function utils market baskets marginal utility law of diminishing marginal

utility indifference curves substitutes complements perfect substitutes perfect complements

budget constraint income effect substitution effect price-consumption curve income-consumption curve Engle curve normal goods inferior goods consumer surplus two-part pricing bundle pricing optimal market basket revealed preference marginal rate of substitution consumption path

Utility Theory Assumptions About Consumer Preferences

More is better. Consumers can rank preferences. Consumers ran-order desirability of products.

Utility Functions Descriptive statement relates well-being and

consumption. Marginal Utility

Added benefit is focus of consumers. Law of Diminishing Marginal Utility

Marginal utility eventually declines for everything.

Indifference Curves

Basic Characteristics of Indifference Curves Higher indifference curves are better. Indifference curves do not intersect. Indifference curves slope downward. Indifference curves are concave to origin.

Perfect Substitutes and Perfect Complements Perfect substitutes satisfy the same need. Perfect complements are consumed together.

Budget Constraints

Basic Characteristics of Budget Constraints Shows affordable combinations of X and Y. Slope of –PX/PY reflects relative prices.

Effects of Changing Income and Changing Prices Budget increase causes parallel outward shift. Budget decrease causes parallel inward shift.

Income and Substitution Effects Income (substitution) effect is change in overall

(relative) consumption.

Individual Demand

Price-consumption Curve Shows how consumption is affected by price

changes (movement along demand curve). Income-consumption Curve

Shows how consumption is affected by income changes (shifts from one demand curve to another).

Engle Curves Plot between income and quantity consumed.

Consumption of normal goods rises with income. Consumption of inferior goods falls with income (rare).

Demand Curves and Consumer Surplus

Graphing the Demand Curve Demand curves always slope downward.

Consumer Surplus Value received above amount paid.

Consumer Surplus and Two-Part Pricing: An Illustration Membership fees and user fees extract

consumer surplus for the seller. Consumer Surplus and Bundle Pricing

Bundle pricing extracts consumer surplus for sellers.

Consumer Choice

Marginal Utility and Consumer Choice Optimal consumption maximizes utility. Optimal consumption reflects marginal

utility (benefits) and marginal costs. Revealed Preference

Documented desire. Buyer decisions can be used to infer

consumer preferences.

Optimal Consumption

Marginal Rate of Substitution (MRS) MRSXY = -MUX/MUY and equals indifference

curve slope. MRSXY shows tradeoff in the amount of X and Y

consumed, holding utility constant. MRSXY diminishes as amount of substitution of X

for Y increases. Utility Maximization

Optimality requires PX/PY = MUX/MUY. Optimality requires MUX/PX = MUY/PY.