ACCTG-113 Managerial Economics Midterm Module PDF

MODULE 1 CONSUMER CHOICE AND DEMAND THEORY ========================================== **OBJECTIVES** A. Analyze how consumers make choices based on their preferences, budget constraints, and utility maximization; B. Use demand theory to predict how changes in prices, income, and related goods\' p...

MODULE 1 CONSUMER CHOICE AND DEMAND THEORY ========================================== **OBJECTIVES** A. Analyze how consumers make choices based on their preferences, budget constraints, and utility maximization; B. Use demand theory to predict how changes in prices, income, and related goods\' prices affect market demand; and C. Create effective pricing strategies by applying demand elasticity concepts. Number of hours: 3 hours per week ================================= Values Integration: =================== 1\. Grace in Communication 2\. Creativity and Innovation 3\. Purposeful Expression SUBJECT MATTER DISCUSSION ========================= **I. INTRODUCTION** **Consumer choice and demand theory** are fundamental components of managerial economics, offering crucial insights into how individuals and businesses make decisions in the marketplace. At its core, consumer choice theory examines how individuals allocate their limited resources among various goods and services to maximize their utility or satisfaction. This theory provides a framework for understanding consumer behavior, focusing on the principles of utility maximization, budget constraints, and preferences. **Demand theory** complements this by analyzing how these **consumer choices** aggregate to influence market demand. It explores the relationship between the price of goods and the quantity demanded, incorporating concepts such as price elasticity, which measures how sensitive consumers are to price changes. By understanding demand elasticity, firms can predict how changes in pricing, income levels, and the prices of related goods will affect overall demand. They equip managers with the knowledge to make strategic decisions that align with consumer preferences and market dynamics, ultimately driving business success and competitive advantage. **II. LESSON INPUTS** **Consumer Choice: What Is It?** Photo taken from: How consumers choose what to buy is known as **consumer choice**. It examines the factors that influence consumers to choose a particular brand, how much they are willing to spend, and why they prefer one product over another. Understanding how consumers make choices involves exploring several key concepts in consumer choice theory. Here's an overview of how preferences, budget constraints, and utility maximization interact to shape consumer behavior and how changes in income or prices can affect demand: ### **1. Consumer Preferences:** Preferences reflect a consumer's likes and dislikes and determine the value they place on different goods and services. ***Principle**:* Consumers have well-defined preferences that allow them to rank different bundles of goods according to their satisfaction or utility. These preferences are typically represented by indifference curves on a graph, where each curve represents combinations of goods that provide the same level of satisfaction. **Key Concepts**: - **Indifference Curves**: Curves that show combinations of goods between which a consumer is indifferent, meaning each combination yields the same level of utility. - **Marginal Rate of Substitution (MRS)**: The rate at which a consumer is willing to substitute one good for another while maintaining the same level of satisfaction. It reflects the consumer\'s willingness to trade off one good for another. ### **2. Budget Constraints:** A budget constraint represents the combination of goods and services a consumer can afford given their income and the prices of those goods. ***Principle**:* The budget constraint is a line that shows the maximum possible quantity of one good that can be purchased for each possible quantity of another good, given the consumer's income and the prices of goods. It's calculated using the formula: Budget Constraint: P~x~⋅Q~x~+P~y~⋅Q~y~=I where: - P~x~\_and P~y~ are the prices of goods X and Y, - Q~x~ and Q~y~ are the quantities of goods X and Y, - I is the consumer's income. **Key Concepts**: - **Budget Line**: The line representing all possible combinations of two goods that a consumer can buy with their given income. - **Shifts in Budget Line**: Changes in income or prices will shift the budget line. An increase in income shifts the budget line outward, while a price change alters the slope of the line. ### **3. Utility Maximization:** Is the process by which consumers choose the combination of goods and services that maximizes their satisfaction given their budget constraint. ***Principle**:* Consumers allocate their income to maximize their total utility, choosing the combination of goods where the highest level of satisfaction is achieved under the constraint of their budget. **Key Concepts**: - **Utility Function**: A mathematical representation of consumer preferences, showing how different combinations of goods provide different levels of satisfaction. - **Optimal Choice**: Occurs where the highest indifference curve is tangent to the budget line. At this point, the marginal rate of substitution (MRS) between the two goods is equal to the ratio of their prices. ### **4. Impact of Changes in Income and Prices** A. **Change in Income** - **Increase in Income**: When consumer income increases, the budget line shifts outward, allowing consumers to afford more of both goods. This typically leads to an increase in the quantity demanded of normal goods (goods whose demand rises with income) and may also affect the consumption of inferior goods (goods whose demand decreases as income increases). - **Decrease in Income**: A reduction in income shifts the budget line inward, reducing the quantities of goods a consumer can purchase. This can lead to a decrease in the quantity demanded of normal goods. B. **Change in Prices** - **Price Increase**: An increase in the price of a good rotates the budget line inward, reducing the quantity of that good a consumer can afford. This generally leads to a decrease in the quantity demanded of the more expensive good due to the substitution effect (shifting consumption to cheaper alternatives) and income effect (feeling poorer and buying less overall). - **Price Decrease**: A decrease in the price of a good rotates the budget line outward, increasing the quantity of that good a consumer can afford. This typically leads to an increase in the quantity demanded of the cheaper good due to the substitution effect and income effect. **Demand Theory: What Is It?**  Photo taken from: **Demand Theory** is a fundamental concept in economics that explores how consumers' purchasing decisions are influenced by changes in prices and other factors. It provides a framework for understanding the relationship between the price of a good or service and the quantity demanded by consumers. Here's a detailed explanation of demand theory and how to apply it to forecast market demand: ### **1. Basics of Demand Theory** A. **Law of Demand:** The Law of Demand states that, all else being equal, as the price of a good or service decreases, the quantity demanded increases, and as the price increases, the quantity demanded decreases. Photo taken from: ***Rationale**:* This inverse relationship is due to the substitution effect (consumers switch to cheaper alternatives as prices rise) and the income effect (as prices fall, consumers feel richer and buy more). B. **Demand Curve:** The demand curve is a graphical representation of the Law of Demand. It shows the relationship between the price of a good and the quantity demanded. ***Shape:*** Typically downward sloping from left to right, indicating that lower prices lead to higher quantities demanded. Photo taken from: C. **Demand Schedule:** A demand schedule is a table that lists the quantity of a good that consumers are willing to buy at various prices. Photo taken from: ### **2. Factors Affecting Demand** Besides price, several other factors can influence demand: - **Income**: An increase in consumer income generally increases demand for normal goods (goods for which demand rises as income rises) and decreases demand for inferior goods (goods for which demand falls as income rises). - **Prices of Related Goods**: The demand for a good can be affected by the prices of substitutes (goods that can replace each other) and complements (goods that are used together). - **Consumer Preferences**: Changes in tastes and preferences can shift the demand curve. - **Expectations**: Future expectations about prices or income can affect current demand. - **Number of Buyers**: An increase in the number of consumers in the market can increase overall demand. ### **3. Forecasting Market Demand** To forecast market demand, we analyze how changes in price and other factors will affect the quantity demanded. Here's a step-by-step approach: A. **Determine the Demand Function**: expresses the quantity demanded of a good as a function of its price and other variables. It can be represented mathematically as: - Q~d~​ = Quantity demanded - P = Price of the good - I = Consumer income - P~r​~ = Prices of related goods (substitutes and complements) - T = Consumer tastes and preferences - E = Expectations about future prices - N = Number of buyers B. **Analyze Price Elasticity** - **Price Elasticity of Demand**: This measures how sensitive the quantity demanded is to changes in price. It's calculated as: **\*Inelastic Demand**: If ∣Ed∣\