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PART 3 MICROECONOMICS OF PRODUCT MARKETS
Prepared by Dr. Amy PengRyerson University
© 2013 McGraw-Hill Ryerson Ltd.
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 2
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 3
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 4
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 5
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 6
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units of A
(p=$1.50)
Units of B
(p=$1.00)
Total expendit
ure
8 0 $12
6 3 $12
4 6 $12
2 9 $12
0 12 $12
Attainable
Unattainable
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 7
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
An increase in income
makes the purchase of
more of either or both
items possible
An increase in income
makes the purchase of
more of either or both
items possible
Income increasesIncome increases
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 8
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Price changes cause
a change in the quantity
demanded of the items
Price changes cause
a change in the quantity
demanded of the items
Price of A risesPrice of A rises
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 9
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
combination
Units of A
Units of B
j 12 2
k 6 4
l 4 6
m 3 8
j
k
lm
I
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 10
Indifference curves are downward slopping
Indifference curves are convex to origin
Marginal rate of substitution (MRS) is the slop of the indifference curve at any point
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
j
k
lm
I
MRS diminishes, so
curve is convex
MRS diminishes, so
curve is convex
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 11
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Indifference map shows a series of
indifference curves, for
different levels of utility
Indifference map shows a series of
indifference curves, for
different levels of utility I4
I1
I2I3
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Point X represents the
optimal attainable
combination of products A and B
Point X represents the
optimal attainable
combination of products A and B
X I4
I1
I2I3
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 13
Marginal utility theory assumes utility is numerically measurable
Indifference curve approach requires only that a consumer specifies if a particular combination of products yield more or less utility than another
At equilibrium, MRS=PB/PA Equivalent to marginal utility approach
sinceA
B
A
B
A
B
B
B
A
A
MU
MUMRS
MU
MU
P
P
P
MU
P
MU
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 14
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
New budget line reflects the price
change
New budget line reflects the price
change
I2I3
I1
I4X
PB=$1.00
PB=$1.50
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 15
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
When the price of product B is
increased from $1.00 to
$1.50, the equilibrium position moves from X to X’,
decreasing thequantity of product B demanded from six to three units.
When the price of product B is
increased from $1.00 to
$1.50, the equilibrium position moves from X to X’,
decreasing thequantity of product B demanded from six to three units.
X'
I2I3
I1
I4X
PB=$1.00
PB=$1.50
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 16
Qu
an
tity
of
A
Quantity of B2 4 6 8 10 12
X'
I2I3I1
I4X
PB QB
$1.00 6
$1.50 3
2
46
10
12
8
Pri
ce o
f B
Quantity of B2 4 6 8 10 12
$0.50
$1.00
$1.50
DB
FIGURE A6-5: Deriving the Demand Curve
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 17
The indifference curve approach to consumer behaviour is based on the consumer’s budget line and indifference curves.
The budget line shows all combinations of two products that the consumer can purchase given product prices and money income.
An indifference curve shows all combinations of two products that will yield the same total utility to a consumer. Indifference curves are downward sloping and convex from the origin.
The consumer is in equilibrium (utility is maximized) at the point on the budget line that lies on the highest attainable indifference curve. At that point the budget line and indifference curve are tangent.
Changing the price of one product shifts the budget line and determines a new equilibrium point.
A price change causes a change in the quantity demanded. The change in the quantity demanded is due to the substitution and income effects.
© 2013 McGraw-Hill Ryerson Ltd. Appendix 6.1 18
