Welcome to EC 209 Managerial Economics- Group A

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? n 3 bundles: A, B and C – Consumer can say which ones she likes, dislikes (Property 1) – Does consumer likes B as much as A? n n No B (more) is better (property 2) – A & C are on the same indifference curve – B is on a higher indifference curve n 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? n n n To go from consumption bundle A to B the consumer is willing to give up _____units 50 of Y to get one additional unit of X. To go from consumption bundle B to C the consumer is 20 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 10 _____ units of Y to get one additional unit of X. Good Y III. I. A 100 B 50 30 C D 20 1 2 3 4 Good X 5

Note: MRS = slope of indifference curve n Between A to B Good Y MRS = -50 n Between B to C I. MRS = -20 n Between C to D A 100 MRS = -10 n How do we find the slope at point B? – Slope of the tangency line at point B n The indifference curve becomes flatter from the left to the right B 50 30 C D 20 1 2 3 4 Good X 6

How does the indifference curve reflect property 4? n For the three Good Y bundles A, B, and III. C, the transitivity I. property implies 100 that 75 50 n if C B n and B A, 1 2 5 n then C A. A C B 7 Good X 7

Can two indifference curves intersect? n n 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? n 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 n I never have coffee without sugar n 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 10

Managerial Economics. Group A n Week Four- Class 2 – Tuesday, September 25 – 15: 10 -16: 00 – Cairnes n Aplia Assignment before 5 today. – Don’t miss it. 11

I got a question n 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. n Chapter 8 of Microeconomics by Frank 12

The Budget Constraint n Suppose Py = € 5 PX = € 2. 5 M = € 50 n Y M/PY=10 Can I afford 2 Xs and 2 Ys? – Yes n Opportunity Set The set of consumption bundles that are affordable. Px. X + Py. Y 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. n P x. X Budget Line 10 + Py. Y = M. X 20 14

What is the slope of budget line? Y n 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 2 Xs – 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 n n n 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? n n 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 a price decrease. 10 20 50 X 17

Consumer Equilibrium n 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. I. M/PX 18 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/PY 1 Complements B Y 2 II A Y 1 I 0 X 1 M/PX 1 X 2 M/PX 2 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/PY 1 Substitutes A Y 1 B Y 2 II I 0 X 1 M/PX 1 X 2 M/PX 2 X 20

Suppose consumer is at her equilibrium. (point A) Now let us increase income 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 M 1/PY B Y 1 M 0/PY II A Y 0 I 0 X 0 M 0/PX X 1 M 1/PX X 21

What if X was inferior good An increase in income will have result in fewer Xs being bought. n Make sure you can show this case graphically. n 22

Managerial Economics n Week Four- Class 3 – September 27 – 15: 10 -16: 00 – Tyndall n Aplia Assignment 2 is due by Tuesday 23

The effects of a price change on quantity of consumption n 1. When X becomes cheaper two things happen Your purchasing power goes up. n This is as if your real income went up. n So you will be able to buy more goods (not just more X) and n reach a higher indifference curve n 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. n n n 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 25

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 26

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 Why? You are still on the same indifference curve (same satisfaction) but buying more just because relative to Y, X is now cheaper C B II I 0 4 SE 6 X 8 27

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 So why are you buying more X? C 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 SE 6 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 29

Giffen good n Is an inferior good for which – SE

Where does the demand curve for X come from? n n n 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? n n n Originally Px = € 10 Q X= 4 Now let’s drop the price to € 5 Q X= 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? n n n the horizontal summation of individual demand curves. When P = 50, Q = 0 When P = 40, Q = 3 $ 2 Individual Demand Curves 50 $ Market Demand Curve 40 D 1 D 2 Q 1 2 3 DM Q 33

How does the demand for a Giffen good look? n You should be able to answer this question on your own. 34

Study Guide 4 contained n Marginal Utility – – n 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 35