Transcript Week 4 - Marietta College

Welcome to
EC 209: Managerial
Economics- Group A
By: Dr. Jacqueline Khorassani
Week Four
1
Class One
Monday, September 24
11:10-12:00
Fottrell (AM)
APLIA ASSIGNMENT IS DUE
BEFORE 5:00 PM TOMMORROW
The next one is due in a week
2
Remember the 4 properties
of consumer preferences
1.
2.
3.
4.
Completeness
More is Better
Diminishing Marginal Rate of
Substitution
Transitivity
3
How does the indifference curve
reflect properties 1 & 2?

3 bundles: A, B and C
– Consumer can say which
ones she likes, dislikes
(Property 1)
– Does consumer likes B as
much as A?


No
B (more) is better (property
2)
– A & C are on the same
indifference curve
– B is on a higher indifference
curve

Represents a higher level of
satisfaction
Good Y
II.
I.
100
A
B
C
33.33
1
3
Good X
4
How does the indifference
curve reflect property 3?



To go from consumption
bundle A to B the consumer
is willing to give up
50
_____units
of Y to get one
additional unit of X.
To go from consumption
bundle B to C the consumer
20
is willing to give up _____
units of Y to get one
additional unit of X.
To go from consumption
bundle C to D the consumer
is willing to give up only
_____
units of Y to get one
10
additional unit of X.
Good Y
III.
II.
I.
A
100
B
50
C
30
D
20
1
2
3
4
Good X
5
Note: MRS = slope of
indifference curve

Between A to B
Good Y
MRS = -50

Between B to C
MRS = -20

Between C to D
I.
A
100
MRS = -10

How do we find the slope
at point B?
– Slope of the tangency line at
point B

The indifference curve
becomes flatter from the
left to the right
B
50
C
30
D
20
1
2
3
4
Good X
6
How does the indifference
curve reflect property 4?
 For the three
Good Y
bundles A, B, and
III.
II.
C, the transitivity
I.
property implies 100
that
75
50
 if C  B
 and B  A,
1 2
5
 then C  A.
A
C
B
7 Good X
7
Can two indifference curves
intersect?




Good Y
What if they did?
C is better than A
II.
(because C represents
I.
more)
A
C
100
Since C and B are on the
same indifference curve, B
should be better than A
too; Is it?
No, as B is on the same
3
2
indifference curve as A
B
Good X
8
What if X and Y were
perfect substitutes?

Example
– You don’t know the difference between
Coke and Pepsi
Indifference
curve is a
straight line
MRS is
constant
Pepsi
A
10
B
9
III
C
8
I
1
2
II
3
Coke
9
What if X and Y were
complements


Example
I never have coffee without sugar
Always 1 coffee + 2
sugars
If 1 coffee + 4 sugars,
am I better off?
No
If 2 coffee + 2 sugars,
not better off
But if 2 coffee + 4
sugars better off
coffee
B
2
I
A
1
2
II
4
sugar
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Managerial EconomicsGroup A

Week Four- Class 2
– Tuesday, September 25
– 15:10-16:00
– Cairnes

Aplia Assignment before 5 today.
– Don’t miss it.
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I got a question

I bought the book from the college
bookshop the other day, but I don't
think that the extra chapter from the
other book was included in the pack.
– You can copy the extra chapter from the
copies in the library.

Chapter 8 of Microeconomics by Frank
12
The Budget Constraint

Suppose
Py = €5
PX = €2.5
M = €50

Y
M/PY=10
Can I afford 2Xs and 2 Ys?
– Yes

Opportunity Set
The set of consumption
bundles that are
affordable.
PxX + PyY  M.
2
2
The Opportunity Set
M/PX=20
13
X
The Budget Line
Y
– The bundles of goods
that exhaust a
consumer’s income.

Budget Line
10
PxX + PyY = M.
X
20
14
What is the slope of budget
line?
Y

Slope of budget line
– Measures the rate at
which you can afford
to substitute X for Y
– For each Y you give
up, you can buy 2Xs
– Slope = -10/20
– Slope = Market Rate
of Substitution
– Slope = - Px / Py
Budget Line
10
9
2
X
20
15
What if budget doubles?
Y
20






From 50 to 100
Does the slope
change?
No
Because prices did
not change
Budget increase
leads to a parallel
shift to the rights.
What will a
budget decrease
do?
10
20
40
X
16
What if price of X goes
down to €1?


A decreases in the
price of good X
rotates the budget
line counter-clockwise
An increases rotates
the budget line
clockwise
Y
New Budget Line for
10
a price decrease.
20
50
X
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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 slope of the
budget line.
Y
M/PY
Consumer
Equilibrium
III.
II.
I.
M/PX
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X
Suppose consumer is at her
equilibrium. (point A)
Now let us drop
the price of X
What is going to
happen next?
Budget line
rotates to the
right
What can you say
about how X and
Y are related to
each other?
Y
M/PY1
Complements
B
Y2
II
A
Y1
I
0
X1 M/PX1
X2
M/PX2
X
19
Suppose consumer is at her
equilibrium. (point A)
Now let us drop
the price of X
What is going to
happen next?
Budget line
rotates to the
right
What can you say
about how X and
Y are related to
each other?
Y
M/PY1
Substitutes
A
Y1
B
Y2
II
I
0
X1 M/PX1
X2
M/PX2
X
20
Suppose consumer is at her
equilibrium. (point A)
Y
What is going to
happen next?
What can you
say about the
nature of X and
Y?
Budget line makes a
shift to the right.
They are both
normal goods
Now let us increase
income
M1/PY
B
Y1
M0/PY
II
A
Y0
I
0
X0 M0/PX
X1
M1/PX
X
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What if X was inferior
good


An increase in income will have result
in fewer Xs being bought.
Make sure you can show this case
graphically.
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Managerial Economics

Week Four- Class 3
– September 27
– 15:10-16:00
– Tyndall

Aplia Assignment 2 is due by Tuesday
23
The effects of a price change
on quantity of consumption

1.
When X becomes cheaper two things
happen
Your purchasing power goes up.




This is as if your real income went up.
So you will be able to buy more goods (not
just more X) and
reach a higher indifference curve
This is called the INCOME EFFECT (IE) of the
price change
24
The effects of a price change
on quantity of consumption
When X becomes cheaper two things
happen
2. Relative to Y, X is now cheaper.





This will make you substitute X for Y
This effect does not make you better off
You stay on the same indifference curve
This is called the SUBSTITUTIN EFFECT
(SE) of the price change
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Let’s show the IE and the SE graphically
Initially, bundle A is
consumed.
Y
What happens if the
price of X goes
down?
A
C
Budget line rotates
counterclockwise
You will move from A
to C buying 4 more
Xs
II
I
0
4
X
8
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SE
To separate the SE from IE
Y
Draw a line tangent to “I“ but
parallel to the new budget
line
A movement from A to B is the
SE.
A
C
Why?
You are still on the same
indifference curve (same
satisfaction) but buying
more just because relative
to Y, X is now cheaper
B
II
I
0
4
6
X
8
SE
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IE
A movement from B to C is the IE.
Why?
Y
The slope of the orange line is the
same as the slope of the new
budget line
Meaning that the ratio of prices are
the same
A
C
So why are you buying more X?
B
Because your real income
(purchasing power) has gone up.
II
I
Is X normal or inferior?
Normal, because income effect is
positive
0
4
6
SE
IE
X
8
28
What if X was inferior?
Income effect will be negative
How can we show it?
Y
SE says buy 2 more Xs
But income effect says buy one less
Xs
C
Since the substitution effect is
stronger than income effect, you
end up buying one more X
A
II
B
I
0
4
X
5 6
SE
IE
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Giffen good
 Is
an inferior good for which
–SE<IE
–When the prices goes down
–You buy less of it
–You must be able to show this
case graphically
30
Where does the demand
curve for X come from?



Two graphs
Top graph is
indifference curve
and budget line
The bottom graph
shows quantity of X
on horizontal axis
and Price of X on
vertical axis
Y
X
P
X
31
Where does the demand
curve for X come from?






Originally Px = €10
QX = 4
Now let’s drop the
price to €5
QX = 6
Connect A’ to B’
You will get the
demand curve for X
Y
B
A
II
I
4
P
10
6
X
A’
B’
5
4
6
X
32
What is the market demand
curve?



the horizontal summation of individual
demand curves.
When P = 50, Q = 0
When P = 40, Q = 3
$
2 Individual Demand
Curves
$
Market Demand Curve
50
40
D1
D2
Q
1
2
1
2
3
DM
Q
33
How does the demand for
a Giffen good look?

You should be able to answer this
question on your own.
34
Study Guide 4 contained

Marginal Utility
–
–
–
–

What is it?
How is it measured?
How does it relate to the indifference?
How does that relate to consumer equilibrium?
For now, we skip it
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