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Consumer Theory and Managerial Economics

Each question must be 250 words each for a paper goal of 1000 words or more.

1. What are the basic assumptions made in consumer theory and how do they affect managerial decision making?

2. Define substitution and income effects and discuss their impact.

3. In what ways can managers and businesses predict percentage changes in quantity demanded and price? Why would they want to?

4. What factors affect price elasticity of demand and what are the effects of those factors?

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1. What are the basic assumptions made in consumer theory and how do they affect managerial decision making?
The assumptions of consumer theory are that 1. There is perfect information 2. Consumers are rational 3. Consumers maximize utility 4. More is preferred to less and 5.Each unit consumed provides less utility than the last (Law of diminishing marginal returns). In order to maximize utility consumers must spend within their budgets and they will buy a good until the marginal utility per dollar must be equal for all goods. It tells us that as more and more of one good that is taken from a consumer, the more and more of the other good they'll need to maintain equal utility. Utility is not something we measure numerically (cardinally) but rather we rank preferences. A consumer can compare two bundles of goods and say which one they prefer. Thus, consumer theory is based on the ideas of constraints and preferences. Managerial decision making should be grounded in these principles - consumers will only buy a good if it compares favorably with other goods, and if it does not strain their budgetary constraints.

2. Define substitution and income effects and discuss their impact.
The income effect explains what happens to the quantity of goods demanded when people can buy more of them. For normal goods, people buy more when they are able to do so. The substitution effect explains what happens when the price of substitute goods change relative to each other. As the price of the ...

Solution Summary

How consumer theory affects managerial decision making.

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