MANAGERIAL ECONOMICS THEORY OF INDIVIDUAL BEHAVIOUR 1

THEORY OF INDIVID BEHAVIOUR What is Microeconomics? –Microeconomics deals with the behavior of individual economic units (consumers, workers, investors, owners of land, business firms etc.) as well as the markets that these units comprise –explains how and why these units make economic decisions. –Economic decision-making in light of “limits”: Limited incomes, limited know- how, limited natural resources, limited number of hours per week, … –Microeconomics is about allocation of scarce resources –Describes trade-offs that economic units face and shows how these trade- offs are best made –Theory of consumer behavior is sub-field of microeconomics describes how consumers allocate limited resources across goods and services

CONSUMER BEHAVIOUR; 3DISTINCT STEPS Consumer behavior is best understood in three distinct steps: –Consumer preferences: Find a practical way to describe the reasons people might prefer one good to another –Budget constraints: Consumer consider prices. –Consumers have limited incomes which restrict the quantities of goods they can buy. –What does a consumer do in this situation? find answer by combining 1.) and 2.) –Consumer choices Given their preferences and limited incomes, consumers choose to buy combinations of goods that maximize their satisfaction. –These combination will depend on the price of various goods. –Understanding consumer choice (and individual demand) will help us understand market demand. 3

WHAT DO ECONOMISTs DO Are assumptions about consumer behavior realistic? Consumer have preferences among the various goods. •Consumers face budget constraints which puts limits on what they can buy. •Consumers choose goods and services so as to maximize their satisfaction (“homo oeconomicus”). ••It is hard to argue with the first two. Third one? ••Are consumers as rational and informed as economists often make them out to be? Behavioral economics incorporates more realistic assumptions about rationality and decision making. •Model of rational consumers is simplification, but has also been successful in explaining much of what we actually observe. •Model of rational consumers is a basic “workhorse” model of economics and has been used widely in fields such as economics, finance, and marketing

OVERVIEW Consumer Behavior •Indifference Curve Analysis. •Consumer Preference Ordering. •II. Constraints •The Budget Constraint. •Changes in Income. •Changes in Prices. •III. Consumer Equilibrium •IV. Indifference Curve Analysis & Demand Curves •Individual Demand. •Market Demand.

CONSUMER PREFERENCES Economic model of (rational) consumer behavior is simple: people choose best things they can afford. ••Let us first clarify the economic concept of “best things” (consumer preferences) and then clarify the meaning of “can afford“ ( budget constraints) ••Consumption bundle: complete list of goods and services that are involved in a consumer choice Includes also a description of when and where goods and services become available. ••Given the choice between 2 bundles of goods a consumer either: Prefers bundle A to bundle B. •Prefers bundle B to bundle A. •Is indifferent between the two: A ∼ B.