Managerial Economics

POST GRAD OCTOBER 2020

Consumer:
Marginal utility
Indifference curve
CONSUMER DEMAND AND BEHAVIOUR
Consumer behaviour
• A consumer is an individual who purchases goods and services from firms for the
purpose of consumption.
• As a manager of a firm, you are interested not only in who consumes the good
but in who purchases

• Consumer opportunities represent the possible goods

and services consumers can afford to consume.

• Consumer preferences determine which of these goods

will be consumed.
Use Marginal Analysis
 • How does your own behavior change
Diminishing when you eat at a buffet?
marginal utility
• Why?
The great outdoors- 1988 film, Steak scene 3’30

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 The law diminishing marginal utility

https://econlife.com/2017/12/starbucks-limited-edition-
frappuccinos
 From marginal utility to indifference curve
• To explain the behaviour of market actors

In the context of two or more goods

• Neoclassical/liberal microeconomics : Consumer
economic utility essentially means satisfaction or
removal of discomfort
• 19th century : the importance of the (law of
diminishing) marginal utility
• Economists  the consumer is not indifferent
between A and B due to the fact they ended up
choosing one over the other.
• One problem = Ordinal but not cardinal
• Because utility is subjective and not technically
measurable.
• Mathematical formulas, being numerical, do not
really apply to consumer theory

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 Indifference curves
• Consumer’s decisions are based upon what
gives more happiness/satisfaction/discomfort
relief – utility
• Marginal utility – Law of diminishing utility
• Early 20th century – 1906 V.Pareto
• Solution : Pricing different goods in terms of
each other or bundles of each other.
• “I don’t care” = you have maximised your
happiness – you are indifferent to or less
satisfied with any other combination of good
compared to what you have  same utility
• Marginal rate of substitution

• Indifference curve : all possible combinations of

two goods that results in the same level of
utility (indifference bundles)
Applications of Indifference Curve Analysis

• Choices by consumers
– Buy one, get one free
– Cash gifts, in-kind gifts, and gift certificates
• Choices by workers and managers
– Income-leisure choice
– Managers preferences

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Indifference curve – marginal rate of substitution
8’30
Constraints
Nature of goods
 Constraints
• While any decision-making environment faces
a host of constraints, the focus of managerial
economics is to examine the role prices and
income play in constraining consumer
behavior.
• Price and income changes impact a
consumer’s budget set and level of
satisfaction that can be achieved.
– This implies that price and income changes will
lead to consumer equilibrium changes.
Doing the best you can given some
constraint…
• Budget constraint
By your income

By the price of the goods

you want

I=(Pa x Qa)+(Pb x Qb)

 Price Changes and Equilibrium

Price increases (decreases) reduce (expand) a consumer’s budget set.

The new consumer equilibrium resulting from a price change depends on consumer
preference. If Goods X and Y are:

substitutes when an increase (decrease) in the price of X leads to an increase (decrease) in the consumption of Y.
complements when an increase (decrease) in the price of X leads to a decrease (increase) in the consumption of Y.
Income Changes and Consumer Behavior

Income increases (decreases) reduce (expand) a consumer’s budget set.

The new consumer equilibrium
resulting from an income change
depends on consumer preferences:
Good X is:
• a normal good when an increase (decrease) in income
leads to an increase (decrease) in the consumption of X.
• an inferior good when an increase (decrease) in income
leads to a decrease (increase) in the consumption of X.

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https://www.investopedia.com/terms/i/incomeeffect.asp 18
 Substitution and Income Effects
• Moving from one equilibrium to
another when the price of one good
changes can be broken down into two
effects:
– Substitution effect: The movement
along a given indifference curve
that results from a change in the
relative prices of goods, holding
real income constant.
– Income effect: The movement from
one indifference curve to another
that results from the change in real
income caused by a price change.

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Substitution and Income Effects

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Example of income effects vs substitution effect

https://voxeu.org/article/integration-global-value-chains-can-reduce-child-labour
 Example of income effects vs substitution effect

https://voxeu.org/article/integration-global-value-chains-can-reduce-child-labour
Example of income effects vs substitution effect
 https://voxeu.org/article/integration-global-value-chains-can-reduce-child-labour
Limits of the methodology
Conclusion
Encouraging the integration of developing-country
firms into GVCs through forward linkages (home
inputs embedded in third-country exports) can
A limitation of the methodology
significantly contribute to SDG Target 8.7, which used in this accounting exercise –
aims at eliminating child labour by 2025, if
appropriate initiatives are in place. The reduction and acknowledged by the authors –
in child labour associated with exporting through is the impossibility of parsing the
forward linkages in GVC is twice as large as the
reduction when all forms of exports are increased data from child labour surveys to
by 1%. distinguish which part of child
On the other hand, increases in the participation of
domestic exporters in GVC downstream is labour is employed by firms involved
associated with increases in child labour. Indeed, in GVCs and which part is employed
encouraging domestic exporters to source from
third countries may lead to increases in efficiency only in the domestic economy.
but is also associated with increases in child labour.

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Key terms of this session
Indifference curve
Marginal utility
Law of diminishing
marginal utility
Substitution effect
Income effect
Constraints