Managerial Economics & Business Strategy
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Transcript Managerial Economics & Business Strategy
Managerial Economics &
Business Strategy
Chapter 4
The Theory of Individual
Behavior
Price Changes and Consumer
Equilibrium
• Substitute Goods
An increase (decrease) in the price of good X leads to
an increase (decrease) in the consumption of good Y.
• Examples:
– Coke and Pepsi.
– Verizon Wireless or T-Mobile.
• Complementary Goods
An increase (decrease) in the price of good X leads to a
decrease (increase) in the consumption of good Y.
• Examples:
– DVD and DVD players.
– Computer CPUs and monitors.
Substitute Goods
When the price of
good X falls and the
consumption of Y
falls, then X and Y
are substitute goods.
(PX1 < PX2)
Pretzels (Y)
M/PY1
A
Y1
B
Y2
I
0
X1 M/PX1
II
X2
M/PX2
Beer (X)
Complementary Goods
When the price of
Pretzels (Y)
good X falls and the
consumption of Y
rises, then X and Y M/PY
1
are complementary
goods. (PX1 > PX2)
B
Y2
II
A
Y1
I
0
X1 M/PX1
X2
M/PX2
Beer (X)
Income Changes and Consumer
Equilibrium
• Normal Goods
Increase (decrease) in income leads to an increase
(decrease) in its consumption.
• Inferior Goods
Increase (decrease) in income leads to a decrease
(increase) in its consumption.
Normal Goods
An increase in
income increases
the consumption of
normal goods.
Y
M1/Y
(M0 < M1).
B
Y1
M0/Y
II
A
Y0
I
0
X0 M0/X
X1
M1/X
X
Inferior Goods
An increase in
income decreases
the consumption of
inferior goods.
Y
M1/Y
B
Y1
(M0 > M1).
M0/Y
A
Y0
I
0
X1X0 M0/X
M1/X
X
When price of a good decreases
• Two things happen
Relative price of the good decreases
• Buy more of the cheaper good
• Substitution Effect
Real income or purchasing power increases
• If buy same bundle of goods bought previously have money left over
• Income Effect
To graphically break up the
effects
• Price decrease causes a rotation on the BC
New optimal bundle
• Look at what would we have bought with this new income
level (new BC) at our old Utility level
Take money away from consumer to keep original Utility level
Price has changed though so cannot keep the slope of the original BC
The Result is Three Points
• Old optimal bundle to new optimal bundle
is the TOTAL EFFECT
• Old optimal bundle to new tangency on
original IC is SUBSTITUTION EFFECT
Same indifference curve
• New tangency on original IC to new
optimal bundle is INCOME EFFECT
Same budget constraint