The Economics Way to

Thinking About Business: Chapter

1
Materi Matrikulasi
Theory Economics for Managers

Dr. Rudi Purwono

 Market
Buyer Market Seller
A market is the process by which buyers and
sellers determine what they are willing to
Demand buy and sell and on what terms. It is the Supply
process by which buyers and sellers decide
the prices and quantities of goods that are
to be bought and sold.

Market Ilustration
Price
Equilibriu S
m QD = The supply curve has a positive
Qs slope because marginal cost
Economics Problem:
rises as quantity increases
P*
1. Resources are in limited amount
2. Scarcity, people want more than they can afford.
The demand curve has a
negative slope because
the marginal value falls as
D
quantity increases

Q* Quantity per period

 Understanding Demand Budget Constraints and Preferences

Economist assume that consumers think 'two goods are not enough'.
Consumers will choose the best bundles they can afford.
Budget constraints: Consumer have limited amount of money to
spend.
How the budget line changes?
x2 Consumer budget
set depends on: 1. Increasing Income 2. Increasing Price
Vertical
intercept
= m/p2 Budget line;
1. price goods x1, x2
x2

slope = – p1/p2
2. price good x2,
m/p2
3. m = income m’/p2
Budget
Budget lines
lines

Budget set
Budget line slope m/p2
determine which
goods more Slope = –
p /p
Horizontal intercept = m/p1 x1 affordable than Slope = –
p1' /p2
Slope = –
p1/p2
others m/p1 m’/p1 x1 m/p1' m/p1
The budget set. The budget set consists of all bundles that x1
are affordable at the given prices and income. Increasing income. An increase in income causes a parallel Increasing
shift outward of the budget line. price. line becomes steeper
budget . 1 becomes more expensive, the
If good
 Understanding Demand Budget Constraints and Preferences

Individuals have their preferences, to consume and satisfy what they

want. There are assumptions about consumer preferences:
1. . Complete > individuals have preferences and can compared about bundles
of goods.
2. Reflexive > any bundle is at least as good as itself. Individuals can rank what
they preferred 'the most' and 'the least'
3. Transitive > Individuals will choose consistently among bundles to maximize
their satisfaction x2
Weakly preferred set:
bundles weakly Bundles that individuals
preferred to (x1 , x 2 )
'least' preferred

The best set

that individuals
preferred

x2
Indifference in this line, bundle of
curve:
bundles goods that
indifferent individuals preferred
to (x1 , x 2 )
x1 x1
 Understanding Demand Example of Preferences
3. Bads
1. Perfect Substitutes 2. Perfect Complements ANCHOVIES

LEFT SH OES
x2 Indifference
curves

Indifference curves

Indifference
curves

PEPPERONI

x1 R I G H T SH OE S

4. Neutral Goods 5. Monotonic Preferences Different characteristics of goods,

A N C H OV I E S
x2 have their own indifference curve.
Indifference curve also measure
Better consumer willingness to pay
bundles
In ilustration 5 (monotonic
preferences) define that better
Indifference (x1, x2 ) bundles have a higher utility for
curves
individual.
Higher utility of a bundle of goods,
Worse
bundles more satisfy individual was.

PEPPERONI x1
 Understanding Demand Optimal Choice

Consumer choose the most preferred bundles, which matches with their budget constraints

x2

Indifference
curves

Highest indifference curve

Optimal -> most preferred bundle
choice
People will x*
consume at x1* 2
dan x2* But because it is not beneath
their budget constraints line,
that is not their optimal choice

x1 x1
*
 The Economics Way to
Utility and Demand
Thinking About Business

Materi Matrikulasi
Theory Economics for Managers

Dr. Rudi Purwono

 There are three axioms about consumer preferences with rational choice:
1. Complete > individuals have preferences and can compared about bundles of goods.
2.Reflexive > any bundle is at least as good as itself. Individuals can rank what they preferred
'the most' and 'the least'
3.Transitive > Individuals will choose consistently among bundles to maximize their
satisfaction.

Utility
Given these assumptions, it is possible to show that people are able to rank in order all
possible situations from least desirable to most desirable.
Economists call this ranking utility
if A is preferred to B, then the utility assigned to A exceeds the utility assigned to B
U(A) > U(B)
 Utility rankings are ordinal in nature
they record the relative desirability of commodity bundles
Because utility measures are not unique, it makes no sense to consider how much
more utility is gained from A than from B
It is also impossible to compare utilities between people
Utility is affected by the consumption of physical commodities, psychological
attitudes, peer group pressures, personal experiences, and the general cultural
environment
Economists generally devote attention to quantifiable options while holding constant the
other things that affect utility
ceteris paribus assumption
Assume that an individual must choose among consumption goods x1, x2,…,
xn The individual’s rankings can be shown by a utility function of the form:
utility = U(x1, x2,…, xn; other things)this function is unique up to an order-
preserving transformation
 Economic Goods
Economic Goods
• In the utility function, the x’s are
assumed to be “goods”
– more is preferred to less
Quantity of y
Preferred to x*, y*

y*

?
Worse
than
x*, y* Quantity of x
x*
 Indifference Curve
• An indifference curve shows a set of
consumption bundles among which
the individual is indifferent
Quantity of y
Combinations (x1, y1) and (x2,
y2) provide the same level of
utility
y1

y2 U1

Quantity of x
x1 x2
 Marginal Rate of Substitution
• The negative of the slope of the • MRS changes as x and y change
indifference curve at any point is – reflects the individual’s willingness to trade y
for x
called the marginal rate of
Quantity of y At (x1, y1), the indifference curve is steeper.
substitution (MRS) The person would be willing to give up more
y to gain additional units of x
Quantity of y
dy
MRS   At (x2, y2), the indifference curve
is flatter. The person would be
dx U U 1 y1 willing to give up less y to gain
y1 additional units of x
y2 U1
y2
U1
Quantity of x
Quantity of x x1 x2
x1 x2

Intuitively, it seems that the assumption of decreasing marginal utility is related to the concept of a
diminishing MRS
this is independent of how utility is measured
diminishing marginal utility depends on how utility is
measured
 Demand
The optimal levels of x1,x2,…,xn can be expressed as functions of all prices and income
These can be expressed as n demand functions of the form: x1* = d1(p1,p2,…,pn,I)
x2* = d2(p1,p2,
•
For example: Demand for Coke …,pn,I) •
1.50
•
xn* = dn(p1,p2,…,pn,I)
Price of Coke ($)

if price increasing, the quantity

of coke demanded
1.00
decreasing
0.75

0.50 Demand

0 1 2 3 4 5
Quantity of Coke
 Elasticity: consumers’ responsiveness to price
changes
Price elasticity of demand > measure the responsiveness of consumer, in terms of the
quantity purchased to a change in price. Everything else hels constant (ceteris paribus)

Figure Elastic and inelastic demand

6.3
P2
Demand curves differ in their relative
Price of Coke ($)

elasticity. Curve D1 is more elastic than

P1 curve D2, in the sense that consumers
on curve D1 are more responsive to a
given price change (P2 to P1) than are
consumers on curve D2.

D2 D1 Consumer relatively sensitive response

to price changes.
0 Q1 Q2 Q3 If the price goes up or down, consumer will respond
to quantity of good their demanded.
Quantity of Coke
 Demand is elastic
if:* total consumer expenditures rise when the price falls, or
* total consumer expenditures fall when the price rises.

Demand is inelastic if:

* total consumer expenditures rise when the price rises, or
* total consumer expenditures fall when the price falls.

Demand is unitary elastic if when total revenues remain unchanged with an

increasing or decreasing in the price.
 Percentage change in quantity Change in price
Ed ¼ ÷ Figure 6.4inChanges
Changes in thecoefficient
elasticity
Percentage change in price Initial price elasticity
11 coefficient
The elasticity coefficient decreases
a
10
b Elastic demand Ed > 1 as a firm moves down the demand
9 Inelastic demand Ed < 1
Ed > 1
Unitary elastic demand Ed = 1
curve. The upper half of a linear
8
demand curve is elastic, meaning
Price per unit ($)

7
that the elasticity coefficient is
6
greater than one. The lower half is
5
Ed = 1
inelastic, meaning that the elasticity
4
Ed < 1 coefficient is less than one. This
3
2
c means that the middle of the linear
d
1 demand curve has an elasticity
coefficient equal to one.
0 10 20 30 40 50 60 70 80 90 100 110
Quantity
 The Individual’s Demand Curve
Quantity of y As the price px
of x falls...
…quantity of x
demanded rises.
px’

px’’

px’’’

U3
U2 x
U1

x1 x2 x3 x’ x’’
Quantity of x x’’’ Quantity of x
I = px’ + p y I = px’’ + py I = px’’’ + py
 If there are only two goods (x and y), we can simplify the notation
x* = x(px,py,I)
y* = y(px,py,I)
Prices and income are exogenous, the individual has no control over these parameters

Changes in Demand
• If x decreases as income rises, x is
• If both x and y increase as income an inferior good
rises, As income rises, the individual chooses
to consume less x and more y
x and y are normal goods Quantity of y
As income rises, the individual chooses
Quantity of y to consume more x and y Note that the indifference
C
curves do not have to be
“oddly” shaped. The
B
C B U3 assumption of a diminishing
MRS is obeyed.
A U3 U2
U2 A
U1
U1
Quantity of x
Quantity of x

Normal goods > if income increasing (or decreasing) than

Inferior goods > if income increasing than demand is decreasing
demand also increasing (or decreasing)
 Changes in Goods Price
Changes in a Good’s Price
Suppose the consumer is maximizing
Quantity of y
utility at point A.

If the price of good x falls, the consumer

will maximize utility at point B.
B

A
U2

U1

Quantity of x
Total increase in x
Faktor-faktor yang
mempengaruhi
permintaan individu
Demand dalam
perekonomian
PERMINTAAN
DOMESTIK
Permintaan dalam perekonomian Indonesia

C
G

I
NX
SHOCK IN DEMAND Pandemi COVID-19
terima kasih

Dr. Rudi Purwono