Managerial Economics & Business Strategy Chapter 4 The Theory of Individual Behavior

Consumer Behavior Consumer Opportunities n The possible goods and services consumer can afford to consume. Consumer Preferences n The goods and services consumers actually consume. Given the choice between 2 bundles of goods a consumer either n Prefers bundle A to bundle B: A  B. n Prefers bundle B to bundle A: A  B. n Is indifferent between the two: A  B.

How do you measure utility? Construct an artificial measure called a UTIL Remember we assume people are rational What does it mean to be rational? n Will not consume a bad voluntarily All consumed goods have utility or you would not consume it.

What do we use to measure this utility? Marginal Utility n Change in total utility divided by the change in quantity Principle of Diminishing Returns n For a given period of time the MU gained from consuming equal successive units of a good will eventually decline as the amount consumed increases. How do you compare utility of different units?

How do we? Example: What is the MU of an apple vs. an orange? Relative Marginal Utility of the good MU per dollar of purchase price

Decision Making Process If the MU of good A relative to its price is greater than the MU of good B relative to its price we should buy more of A and less of B Compare of each good AND…spend all of our money

Example MU orange = 30 MU apple = 20 Income = $20 Buy 10 oranges for $1 each and 10 apples for $1 each Good??

Not Good… We could do better by buying more oranges because per dollar it brings more satisfaction Buy one more orange and one less apple increases TU What happens to the MU of oranges? n Decreases MU of oranges n Why? n Diminishing MU when buy more What happens to the MU of apples? n Increases MU of apples n Why? n Increasing MU when buy less When do we stop?

Consumer Equilibrium The combination of goods where our income can’t be redirected to improve our situation Therefore:

Example P M =$2 ; P c =$1; Income=$60 # muffinsMU M # cookiesMU c

P a =$1;P b =$1? P a =$0.50;P b =$1? Income = $7.00 #a#a MU a #b#b MU B

Can we do it?? On the next slide are schedules which show the total utility measured in terms of utiles which President Strassburger would get by purchasing various amounts of product Apples, Bananas, Carrots, and Donuts. Assume that the price of Bananas is $4, the price of Donuts is $18, the price of Apples is $1, the price of Carrots is $6, and that President Strassburger’s income is $135. What quantities of Bananas, Donuts, Apples, and Carrots will President Strassburger purchase?

Can you do it?? B TU MUMU /P D TU MUMU /P A TU MUMU /P C TU MUMU /P