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    Economic Analysis of Business Decisions

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    Afra Mussad
    This document discusses consumer equilibrium when consuming two goods. It provides an example consumer equilibrium problem and solves it using marginal rate of substitution. It then introduces indifference curves as an ordinal approach to analyze consumer choice between two goods. It discusses the characteristics of indifference curves and how consumer equilibrium occurs at the point of tangency between the budget line and the highest attainable indifference curve.

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    Economic Analysis of Business Decisions

    Uploaded by

    Afra Mussad
    32 views19 pages
    This document discusses consumer equilibrium when consuming two goods. It provides an example consumer equilibrium problem and solves it using marginal rate of substitution. It then introduces indifference curves as an ordinal approach to analyze consumer choice between two goods. It discusses the characteristics of indifference curves and how consumer equilibrium occurs at the point of tangency between the budget line and the highest attainable indifference curve.

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    Economic 9

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    This document discusses consumer equilibrium when consuming two goods. It provides an example consumer equilibrium problem and solves it using marginal rate of substitution. It then introduces indifference curves as an ordinal approach to analyze consumer choice between two goods. It discusses the characteristics of indifference curves and how consumer equilibrium occurs at the point of tangency between the budget line and the highest attainable indifference curve.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    32 views19 pages

    Economic Analysis of Business Decisions

    Uploaded by

    Afra Mussad
    This document discusses consumer equilibrium when consuming two goods. It provides an example consumer equilibrium problem and solves it using marginal rate of substitution. It then introduces indifference curves as an ordinal approach to analyze consumer choice between two goods. It discusses the characteristics of indifference curves and how consumer equilibrium occurs at the point of tangency between the budget line and the highest attainable indifference curve.

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    Economic analysis of Business

    decisions
    Lecture 9
    Conditions of consumer equilibrium for more
    than one commodity (x and y)
    MUX/PX=MUy/Py=MUM/PM=…= Mun /Pn
    Example
    • Below is the MUX and MUy schedules, given
    PX= $4 and Py=$3 per unit, consumer income =
    $41 . What is the consumer equilibrium that
    satisfy the income condition.
    Unit 1 2 3 4 5 6 7
    MUX 30 28 20 16 12 10 8
    MUy 40 36 32 24 18 14 9
    Consumer eq. is attained when :
    MUX/PX=MUy/Py
    Unit 1 2 3 4 5 6 7
    MUX/PX 7.5 7 5 4 3 2.5 2
    MUy/Py 13.3 12 10.7 8 6 4.7 3
    The indifference curve analysis
    (ordinal approach)
    • This approach is different from the utility
    theory in that, the utility gained can't be
    measured. However, the consumer can
    arrange the different combinations of
    commodities in order. (commodity bundles)
    Assumptions of the indifference curve (IC)
    approach
    1)Utility is immeasurable.
    2)Tastes and preferences are said to be
    transitive and convient.
    Consumer equilibrium in the context of
    indifference curve (IC)
    • The elements of this approach(ordinal approach):
    1.Indifference curve (IC):
    • IC is constructed on the basis of two-commodity
    model i.e.: the consumer spend his/her income
    to purchase two commodities say x and y.
    • The indifference curve represents combinations
    of units of x and y as points on the curve. Each
    combination yields the same level of utility for
    the consumer.
    Given the following combinations of x and y we
    : can construct IC
    Units of x Units of y
    20 4
    18 6
    12 10
    6 15
    2 24
    There are numerous IC to reflect different levels
    of utility. More than one IC are referred to as
    indifference map
    Characteristics of ICs
    1. They are convex in shape to the origin.
    2. They have negative slope from left to right.
    3. Indifference curve distant from the origin
    have a high level of utility.
    4. Indifference curves never intersect each
    other.
    a = om + oh
    b = oN + oK
    c = oN + oL
    a= b( on IC2)
    a=c (on IC1)
    b=c
    oN + oK=oN + oL
    ok=ol but ok >oL
    • In the context of IC analysis we could have the
    value of one commodity in terms of units of
    the other commodity. That what is come to be
    known as “marginal rate of substitutions”
    between the two commodities.
    • Say marginal rate of substitution of x and y
    (MRSx,y) is the number of units of y to forego in
    order to gain on unit of x.
    • MRSx,y =
    • MRSy,x =
    Budget or income constraints.2
    • The consumer income is the total payment made for
    purchase of the commodities ( say x and y).
    • Payments made for x equals units of x (Qx) times
    price per unit of x (Px) =>(Qx.Px )
    • Similarly, Payments made for y equals units of y (Qy)
    times price per unit of y(Py) =>(Qy.Py )
    • If we denote income by I then the income equation :
    I = Qx.Px + Qy.Py
    Units of Y
    I/Py

    I/PX

    Units of X
    I = $120 , Px= 3 , Py=5

    )120/5( 24

    )120/4( 40
    Slope = I/Py I/PX
    = I/Py PX/I = PX/PY
    Changes in income
    1.Nominal change of income:
    That is the change in cash income (say from $2000 to
    $3000 or from $2000 to $1000).
    ’’N

    ’N

    ’M M ’’M
    2.Real income change:
    • That is a result of price changes which result in purchasing
    power of nominal income.
    • Increase in prices lower the real income while decrease in
    prices has a reverse effect.
    Consumer equilibrium in the context of IC

    • Consumer equilibrium is attained at the combination


    which is reflected by the tangency point between the
    budget constraint and the appropriate IC :
    • Condition of consumer eq. is : slope of budget
    line = slope of IC
    • = MRSx,y

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