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FB5001
Managerial Economics
Dr. LI Kui Wai (李鉅威)
Email: [email protected]
http://fbstaff.cityu.edu.hk/efkwli/
Tel: 2788 8805, Room P7312
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Lecture 1
Demand, Elasticity & Behavior
ƒ What is demand?
ƒ The concept of utility and the relevance of
Marginal Utility.
ƒ Downward sloping demand curve. Why?
ƒ The question of revealed preference.
Notional vs actual demand.
ƒ Market price and consumer surplus.
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Demand Curve: Explained
ƒ Demand curve is a graph showing the
quantity one will buy at each price. Market
demand is the sum of individual demands.
ƒ The slope of demand curve gives the
marginal benefit of each additional unit of
consumption. Each additional unit gives
less benefit than the previous unit
(diminishing).
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The Demand Curve
P / MB
D
Q
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Determinants of Demand
ƒ D = f (P, Y, Po, T). Can add specific ones.
ƒ Y changes: Normal good where demand
is positively related to Y. Inferior goods
where demand is negatively related to Y.
ƒ Po changes: Complements if an increase
in the price of 1 good causes a fall in the
demand for the other. Substitute if an
increase in the price of 1 good causes a
rise in the demand for the other.
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Movement Along and Shift
P
D2
D1
Q
ƒ Movement along:
change in price.
Change in quantity
demanded.
ƒ Shift: change in Y, Po
and T. Change in
demand.
ƒ Changes in
determinants show
different effect on
demand.
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Marginal Benefit vs Price
ƒ Total benefit is the benefit yielded by all
units purchased.
ƒ Lack of market information or buyer’s
revealed preference. A single market price
means marginal benefit can exceed price.
ƒ Buyer surplus is the difference between a
buyer’s marginal benefit and market price.
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Buyer Surplus
P
Buyer surplus
Total benefit
D
Q
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Elasticity
ƒ Demand elasticity is the responsiveness
of demand to changes in an underlying
factor.
ƒ Price elasticity is the percentage change
in quantity demanded as a result of a
percentage change in its own price.
ƒ Arc: % change in Qd / % change in P.
ƒ Point: (δQ/Q)/(P/P) or δQ/δP. P/Q
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Elastic vs Inelastic
ƒ Demand is price elastic /inelastic when a
1% change in price leads to a more than
/less than 1% change in quantity
demanded.
ƒ Look at absolute value, not the –ve sign.
ƒ Progress check: What are the business
implications of elasticity?
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Diagram
Elastic
Inelastic
ƒ Intuitive factors:
ƒ Availability of
substitute.
ƒ A competitive market?
ƒ Prior commitments
(spare parts).
ƒ Share in buyer’s
income.
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Identification Problem
ƒ Any two points give a demand curve, or
two demand curves, or intersection points?
ƒ Use of observed data is questionable.
ƒ Demand estimation can be a problem.
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Consumer Behavior
ƒ The indifference curve.
ƒ Consumer chooses between two goods,
and decides on a mixture of goods
consumed.
ƒ Utility levels are formed from the
consumption of goods. The higher the
level of utility, the better for the individual.
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The Indifference Curve
Qa
U
Qb
ƒ The utility function: U =
f(Qa, Qb)
ƒ Total derivative:
(dU/dQa)dQa+(dU/dQb)d
Qb
ƒ dU/dQa is marginal utility
of Qa. (MUa)
ƒ dU/dQb is marginal utility
of Qb. (MUb)
ƒ Slope of indifference
curve: MUa/MUb
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The Budget Line
ƒ Ability to consume
depends on one’s
income constraint.
ƒ The budget line:
Y = PaQa + PbQb
ƒ Slope of the budget
line is: Pa/Pb
Qa
Qb
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Consumer Equilibrium
ƒ Equilibrium reaches
when the indifference
curve is tangential to
the budget line, ie
MUa/MUb = Pa/Pb
E
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The 2 Effects
ƒ Two effects when a price change.
ƒ The income effect: consumer’s income is
higher when price falls, lower when price
rises.
ƒ The substitution effect: Pa/Pb changes
when price changes. Consumer will move
to a higher or lower indifference curve as
a result.
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The Substitution Effect
ƒ This is the change in consumption due
purely to a change in the relative price of
a commodity given the level of money
income is so adjusted that the original
level of utility is kept. The effect is
restricted to a movement along the
original indifference curve.
ƒ Careful explanation in Diagrams 4.18 and
4.19 from book by K W Li
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The Income Effect
ƒ Defined as a change in consumption due
purely to a change in real income, relative
prices held constant. The income effect is
shown by the change or jump in the
indifference curve.
ƒ What would happen if the income effect is
negative?
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