Individuals make choices that maximise their utility or well-being, given the available resources and information
Assumptions of Rational Decision Making
Consistency: Individuals have stable preferences and will make the same choice when faced with the same set of options
Completeness: People can compare and rank all possible alternatives to make a decision
Transitivity: If option A is preferred to option B, and option B is preferred to option C, then option A is preferred to option C
Rationality: Individuals will always choose the option that maximises their utility or well-being
Utility
Satisfaction or happiness that an individual derives from consuming a good or service
Total Utility
Overall satisfaction obtained from consuming a certain quantity of a good
Marginal Utility
Additional satisfaction gained from consuming one more unit of the good
Law of Diminishing Marginal Utility: As a person consumes more units of a good, the additional satisfaction (marginal utility) derived from each additional unit diminishes
Imperfect Information
Individuals often face imperfect information, which may lead to less than optimal decisions
Bounded Rationality
Due to limited cognitive abilities and time, individuals may make decisions that are "good enough" rather than completely optimal
Rational decision making (from a firm's point of view)
The process by which a company makes choices and allocates its resources to maximise profits and achieve its business objectives
Firm's primary goal
Maximise shareholder wealth or long-term value
Principles and considerations in rational decision making for a firm
Profit Maximisation
Cost-Benefit Analysis
Market Demand and Pricing
Production and Resource Allocation
Investment Decisions
Risk Management
Competitive Analysis
Long-Term Perspective
Information and Data Analysis
Legal and Ethical Considerations
Real-world business decisions are often influenced by external factors, uncertainties, and behavioural aspects of decision-makers, so firms may make "satisficing" decisions that are considered good enough, even if they are not strictly optimal
what does it mean when we say that consumers aim to maximise utility
when making decisions, people aim to maximise their own welfare
they have limited income and they allocate money in a way that gives them the highest total satisfaction
assumptions about rational consumers
consumers choose independently (my preferences don't affect your choices)
a consumer has fixed and consistent tastes and preferences
consumers gather complete information on the alternatives available in the market
consumers always make an optimal choice given their preferences
do consumers always behave rationally
consumers rarely behave in a well-informed and rational way:
herd behaviour
habitual behaviour
poor computational ability
heuristics/shortcuts
framing effects
demand
the quantity that purchasers are willing and able to buy at a given price in a given period of time
effective demand
only if demand for a product is backed up by a willingness and ability to pay the market price
basic law of demand
demand varies inversely with price - lower prices make products more affordable for consumers
why does the demand curve slope downwards - law of diminishing marginal utility
as quantity consumed increases, the value to the consumer of each additional unit decreases and therefore as consumers are rational, the price they are willing to pay decreases
why does the demand curve slope downwards - income effect
as the price of the good falls, the consumers can buy more of that good with their income; their money goes further, so they can afford to buy more
why does the demand curve slope downwards - substitution effect
when the price of a good falls, its substitutes become relatively more expensive, consumers switch away from other goods towards the relatively cheaper good
demand curve
shows how much of a good/service consumers want at each price - only changes in market price of the product causes a movement along the demand curve
higher price - contraction of quantity demanded, ceteris paribus
lower price - expansion of quantity demanded, ceteris paribus
what causes a shift in demand curve
expectations of sales in the future
consumer tastes
price of substitute goods
price of complimentary goods
income
seasonality
how do changing seasons affect the demand for goods
seasonality refers to fluctuations in output and sales related to the season
changing prices of a substitute goods/services in competitive demand
fall in the price of a good makes it relatively cheaper compared to substitutes
some consumers will switch to that good leading to higher demand - depends on whether products are close substitutes
changing price of a complement - products in joint demand
fall in the price of a good leads to an expansion of quantity demanded - may lead to higher demand for the complement good
changes in real income of consumers
real income increases, ability to purchase goods and services increases causing outward shift in demand curve - unless it is an inferior good
changes in the distribution of income - more equal distribution of income can increase total demand as relatively poorer consumers spend a higher proportion of their income
interest rates can affect deman
changes in consumer preferences, such as:
effects of advertising and marketing
changes in the size and age structure of a population
seasonal factors for some goods and services
social and emotional factors
what affects demand - PIRATES
Population
Income
Related goods
Advertising
Tastes and fashion
Expectations
Seasons
derived demand
demand for a factor of production used to produce another good or service
composite demand
exists where goods have more than one use - an increase in the demand for one product leads to a fall in supply of the other
elasticity
sensitivity or responsiveness
Price Elasticity of Demand (PED)
the responsiveness of quantity demanded to a change in price
what determines Price Elasticity of Demand
number of close substitutes available for consumers
price of the product in relation to total income
cost of substituting between different products
brand loyalty and habitual consumption
degree of necessity/luxury
PED=%ΔP%ΔQD
the value is called the coefficient of PED, we know it is always negative so we just talk about the positive value
PED
if the % change in price leads to a bigger change in quantity demanded, i.e. the % change in quantity demanded is highly responsive, this means the relationship is elastic (more than 1)
PED
the % change in price leads to a smaller change in quantity demanded, i.e. the % change in quantity demanded is not responsive, this means relationship is inelastic (less than 1)
why is PED always a negative number
the demand curves show an inverse relationship, i.e. as prices rise, quantity falls and as price falls, quantity rises
PED is -∞
described as perfectly elastic, only 1 price consumers are willing to pay
elastic PED
% change in price is less than the % change in quantity demanded