DEMAND - The amount of a good or service Price of a good -As you would expect, consumers perceive falling quality, or

that consumers in a market are willing and able consumers are willing and able to buy more of a displeasing appearance, or diminished
to purchase during a given period of time (e.g., good the lower the price of the good and will healthfulness.
a week, a month) is called quantity demanded buy less of a good the higher the price of the
good. Price and quantity demanded are Increase in the number of consumers - an
Three types of demand relations negatively (inversely) related because when increase in the number of consumers in the
the price of a good rises, consumers tend to market will increase the demand for a good,
General demand functions - which show how and a decrease in the number of consumers will
quantity demanded is related to product price shift from that good to other goods that are
now relatively cheaper. Conversely, when the decrease the demand for a good, all other
and five other factors that affect demand
price of a good falls, consumers tend to factors held constant
Direct demand functions - which show the purchase more of that good and less of other Direct Demand Functions: Qd = f (P)
relation between quantity demanded and the goods that are now relatively more expensive.
price of the product when all other variables Price and quantity demanded are inversely A table, a graph, or an equation that shows how
affecting demand are held constant at specific related when all other factors are held constant. quantity demanded is related to product price,
values holding constant the five other variables that
Changes in income - An increase in income can influence demand:
Traditionally, economists have referred to
cause the amount of a commodity consumers
direct demand functions simply as demand The relation between price and quantity
purchase either to increase or to decrease
functions or demand demanded per period of time, when all other
Commodities may be related in consumption in factors that affect consumer demand are held
Inverse demand functions - which give the constant, is called a direct
either of two ways:
maximum prices buyers are willing to pay to
obtain various amounts of product Substitute- an increase in the price of one good demand function or simply demand means that
will increase the demand for the other good the quantity demanded is a function of (i.e.,
The six principal variables that influence the depends on)
quantity demanded of a good or service are Complements - used in conjunction with each
other, demand for one good increases when the A demand schedule (or table) shows a list of
(1) the price of the good or service (P) several prices and the quantity demanded per
price of a related good decreases
(2) the incomes of consumers (M) period of time at each of the prices, again
(3) the prices of related goods and services (PR) Taste - A change in consumer tastes can change holding all variables other than price constant.
(4) the tastes or preference patterns of demand for a good or service. takes on larger
consumers (T) values as consumers perceive a good becoming Demand curve - graph showing the relation
(5) the expected price of the product in future higher in quality, more fashionable, more between quantity demanded and price when all
periods (PE) healthful, or more desirable in any way. A other variables influencing quantity demanded
(6) the number of consumers in the market (N) decrease in T corresponds to a change in are held constant
Qd = f (P, M, PR, T, PE, N ) consumer tastes away from a good or service as
Shifts in Demand - When any one of the five Variables that have the greatest effect on the price of another good, causes producers to
variables held constant when deriving a direct quantity supplied increase production of both goods
demand function from the general demand
relation changes value, a new demand function 1. The price of the good itself. (Price) Technology - The state of knowledge
2. The prices of the inputs used to produce the concerning the combination of resources to
results.
good. (Inputs) produce goods and services
Increase in demand - A change in the demand 3. The prices of goods related in production.
function that causes an increase in quantity (Related goods) Direct supply function - A table, a graph, or an
demanded at every price and is reflected by a 4. The level of available technology. equation that shows how quantity supplied is
(Technology) related to product price, holding constant the
rightward shift in the demand curve
5. The expectations of the producers concerning five other variables that influence supply: Qs = f
Decrease in demand - A change in the demand the future price of the good. (Expectations) (P)
function that causes a decrease in quantity 6. The number of firms or the amount of
demanded at every price and is reflected by a Determinants of supply - Variables that cause a
productive capacity in the industry change in supply (i.e., a shift in the supply
leftward shift in the demand curve (Firms/Capacity) curve)
Determinants of demand - Variables that
change the quantity demanded at each price Change in quantity supplied - A movement
The general supply function shows how all six along a given supply curve that occurs when the
and that determine where the demand curve is of these variables jointly determine the quantity
located: price of a good changes, all else constant
supplied.
M, PR , T, PE, and N Supply schedule - A table showing a list of
The general supply function is expressed possible product prices and the corresponding
Change in demand - A shift in demand, either mathematically as quantities supplied
leftward or rightward, that occurs only when Qs = f(P, PI, Pr, T, Pe, F )
one of the five determinants of demand Supply curve - A graph showing the relation
between quantity supplied and price, when all
changes The prices of goods related in production (Pr)
other variables influencing quantity supplied
SUPPLY - The amount of a good or service Substitutes in production - Goods for which an are held constant
offered for sale in a market during a given increase in the price of one good relative to the
period of time (e.g., a week, a month) is called price of another good causes producers to Inverse supply function - The supply function
quantity supplied increase production of the now higher priced when price is expressed as a function of
good and decrease production of the other quantity supplied:
good P = f (Qs)
Complements in production - Goods for which
an increase in the price of one good, relative to
Direct supply function - A table, a graph, or an Excess demand (shortage) - Exists when Economic value - The maximum amount any
equation that shows how quantity supplied is quantity demanded exceeds quantity supplied buyer in the market is willing to pay for the unit,
related to product price, holding constant the which is measured by the demand price for the
five other variables that influence supply: Qs = f Market clearing price The price of a good at unit of the good
which buyers can purchase all they want and
(P)
sellers can sell all they want at that price. This is Economic value of a particular unit = Demand
Supply price - The minimum price necessary to another name for the equilibrium price price for the unit
induce producers to offer a given quantity for = Maximum amount buyers are willing
sale Principle to pay

Shifts in Supply - A shift in supply occurs only The equilibrium price is that price at which
quantity demanded is equal to quantity
when one of the five determinants of supply (PI, Producer Surplus - For each unit supplied, the
Pr, T, Pe, F) changes value (determinants of supplied. difference between market price and the
supply) When the current price is above the equilibrium minimum price producers would accept to
price, quantity supplied exceeds quantity supply the unit(its supply price)
Increase in supply - A change in the supply
function that causes an increase in quantity demanded. The resulting excess supply induces Social Surplus - The sum of consumer surplus
supplied at every price, and is reflected by a sellers to reduce price in order to sell the and producer surplus, which is the area below
rightward shift in the supply curve surplus. demand and above supply over the range of
If the current price is below equilibrium, output produced and consumed
Decrease in supply - A change in the supply
function that causes a decrease in quantity quantity demanded exceeds quantity supplied. CHANGES IN MARKET EQUILIBRIUM
supplied at every price, and is reflected by a The resulting excess demand causes the
leftward shift in the supply curve unsatisfied consumers to bid up price. Since Qualitative forecast - A forecast that predicts
prices below equilibrium are bid up by only the direction in which an economic
MARKET EQUILIBRIUM - A situation in which, at consumers and prices above equilibrium are variable will move
the prevailing price, consumers can buy all of a lowered by producers, the market will converge
good they wish and producers can sell all of the Quantitative forecast - A forecast that predicts
to the equilibrium price–quantity combination
both the direction and the magnitude of the
good they wish. The price at which Qd = Qs
MEASURING THE VALUE OF MARKET change in an economic variable
Equilibrium price - The price at which Qd = Qs EXCHANGE

Equilibrium quantity - The amount of a good Consumer Surplus - The difference between the
bought and sold in market equilibrium economic value of a good and the price of the
good is the net gain to the consumer, and
Excess supply (surplus) - Exists when quantity
supplied exceeds quantity demanded this difference is called consumer surplus
Marginal Analysis for Optimal Decisions the levels of the activities or choice Involves changing the value(s) of the choice
variables variable(s) by a small amount to see if the
Marginal Analysis - A manager’s decision is objective function can be further increased (in
optimal if it leads to the best outcome under a the case of maximization problems) or further
Optimization problems are also categorized
given set of circumstances decreased (in the case of minimization
according to whether the decision maker can
problems)
Objective function -The function the decision choose the values of the choice variables in the
maker seeks to maximize or minimize. objective function from an unconstrained or If so, the manager continues to make
constrained set of values. incremental adjustments in the choice variables
Optimizing behavior on the part of a decision
until no further improvements are possible
maker involves trying to maximize or minimize Unconstrained Optimization
an objective function. Marginal analysis leads to two simple rules for
An optimization problem in which the decision
solving optimization problems, one for
For a consumer, the objective function is the maker can choose the level of activity from an
unconstrained decisions and one for
satisfaction derived from consumption of unrestricted set of values
constrained decisions
goods, which is to be maximized
These type of problems occur when a decision
Any activity that decision makers might wish to
Maximization problem - An optimization maker can choose any level of activity he or she
undertake will generate both benefits and
problem that involves maximizing the objective wishes in order to maximize the objective
costs. Consequently, decision makers will want
function function
to choose the level of activity to obtain the
Minimization problem - An optimization Constrained Optimization maximum possible net benefit from the activity,
problem that involves minimizing the objective where the net benefit (NB) associated with a
An optimization problem in which the decision specific amount of activity (A) is the difference
function
maker chooses values for the choice variables between total benefit (TB) and total cost (TC)
Activities or Choice Variables from a restricted set of values. These problems for the activity.
 Variables that determine the value of involve choosing the levels of two or more
the objective function. activities that maximize or minimize the NB = TB - TC
 For example, the value of profit objective function subject to an additional
depends on the number of units of Optimal level of activity - The level of activity
requirement or constraint that restricts the
output produced and sold that maximizes net benefit
values of A and B that can be chosen
 The production of units of the good is
the activity that determines the value of Marginal benefit (MB) - The change in total
Marginal Analysis
the objective function, which in this benefit caused by an incremental change in the
case is profit Analytical technique for solving optimization level of an activity
 The decision maker controls the value problems that involves changing values of
of the objective function by choosing choice variables by small amounts to see if the
objective function can be further improved
Marginal cost (MC) - The change in total cost Slope parameter - The slope of the regression Consumption bundle - Two important
caused by an incremental change in the level of line, b = DY/DX, or the change in Y associated assumptions must be made about how people
an activity with a one-unit change in X rank bundles of goods: consumer preferences
must be complete and transitive
Sunk costs- Costs that have previously been Theory of Consumer Behavior
paid and cannot be recovered Complete - Consumers are able to rank all
The Consumer’s Optimization Problem conceivable bundles of commodities
Fixed costs- Costs are constant and must be
As a basic premise for analyzing consumer
paid no matter what level of the activity is Complete preference ordering - For any given
chosen behavior, we will assume that all individuals pair of consumption bundles, consumers must
make consumption decisions with the goal of be able to rank the bundles according to the
Average (unit) cost- Cost per unit of activity maximizing their total satisfaction from
level of satisfaction they would enjoy from
computed by dividing total cost by the number consuming various goods and services, subject consuming the bundles. A consumption bundle
of units of activity to the constraint that their spending on goods would be ranked higher (i.e., preferred) to
exactly equals their incomes. another bundle if the preferred bundle yields
THE SIMPLE LINEAR REGRESSION MODEL -
Regression analysis is a technique used to Few, if any, people have incomes sufficient to more satisfaction than the other, less-preferred
determine the mathematical relation between a buy as much as they desire of every good or bundle. Or, if the two bundles yield exactly the
dependent variable and one or more service, so choices must be made about how to same level of satisfaction, the consumer would
explanatory variables. The explanatory spend their limited incomes. be indifferent between the two bundles and
variables are the economic variables that are would give the two bundles the same ranking.
thought to affect the value of the dependent To keep the income constraint as simple as When a consumer can rank all conceivable
possible, we will not allow consumers either to bundles of commodities, the consumer’s
variable.
spend less than their incomes (i.e., no saving is preferences are said to be complete.
Dependent variable - The variable whose allowed) or to spend more than their incomes
variation is to be explained (i.e., no borrowing is allowed). For example, a consumer who is confronted
with bundles A and B in Figure 5.1
Explanatory variables - The variables that are Properties of Consumer Preferences
thought to cause the dependent variable to must be able to make one of the following three
Consumption bundle - Consumer theory possible responses:
take on different values
requires that consumers be able to rank (or to
Intercept parameter - The parameter that gives order) various combinations of goods and 1. I prefer bundle A to bundle B (denoted as A s
the value of Y at the point where the regression services according to the level of satisfaction B).
line crosses the Y-axis associated with each combination. Such 2. I prefer bundle B to bundle A (denoted as B s
combinations of goods or services are called A).
consumption bundles.
3. I am indifferent between bundles A and B However, we are going to adopt one more willing to accept a smaller reduction in Y for an
(denoted as A ~ B). assumption that will keep matters as simple as equal increase in X in order to stay at the same
possible. level of utility
The consumer’s preferences are complete if the
consumer can do this for every possible pair of We are going to assume that consumers always Marginal Rate of Substitution
consumption bundles. Completeness of the prefer to have more of a good rather than less of
the good. We do recognize that people may The marginal rate of substitution (MRS) measures
preference ordering is essential for our model,
consume so much o something that they become the number of units of Y that must be given up per
because consumers would not be able to unit of X added so as to maintain a constant level
satiated with it and do not want any more.
identify the most satisfying bundle without a of utility.
However, no one would intentionally purchase so
complete ranking of all possible consumption
much of a good that they would be happier to
bundles. Relation Indifference curves are negatively sloped
have less of it. and convex. Moving along an indifference curve,
Transitive - Consumer preferences are when the consumption of one good is increased,
The Utility Function
transitive if A = B, and B = C, then it follows that consumption of the other good is necessarily
A = C. Utility- Benefits consumers obtain from the goods reduced by the amount required to maintain a
and services they consume constant level of utility.
Transitive preference ordering - Consumer
preferences are transitive when they are Utility function - An equation that shows an Indifference Maps - An indifference map is made
consistent in the following way. If bundle A is individual’s perception of the level of utility that up of two or more indifference curves
preferred to bundle B, and bundle B is preferred would be attained from consuming each
to bundle C, then bundle A must be preferred to conceivable bundle o goods: U = f (X, Y) Marginal utility- The addition to total utility that is
bundle C. attributable to the addition of one unit of a good
Indifference curve - A set of points representing to the current rate of consumption, holding
Using the symbols presented above: If A s B, and B different bundles of goods and services, each of constant the amounts of all other goods
s C, then it follows that A s C. Consumer which yields the same level of total utility. A consumed
preferences must be transitive, otherwise fundamental tool for analysing consumer
inconsistent preferences would undermine the behaviour A Marginal Utility Interpretation of MRS
ability of consumer theory to explain or predict
Indifference curves are downward sloping - Economists typically assume that as the
the bundles consumers will choose.
Because the consumer obtains utility from both consumption of a good increases, the marginal
More is preferred to less (nonsatiation) goods, when more X is added, some Y must be utility from an additional unit of the good
taken away in order to maintain the same level of diminishes
Completeness and transitivity are the only
utility. Consequently, indifference curves must be While diminishing marginal utility cannot be
absolutely necessary assumptions for consumer
downward sloping. proved theoretically, falling marginal utility
theory.
Indifference curves are convex - A convex shape appears to characterize the pattern of
means that as consumption of X is increased consumption for most people with most good
relative to consumption of Y, the consumer is