Alternative Behavior: Managerial Implications

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Alternative views of behavior are presented and their resulting managerial implications can be seed for class discussion. The last section of the chapter focuses on how decisions are made when individuals face uncertainty. The Self-Evaluation Problems cover some of the quantitative tools introduced in the chapter, including consumer choice analysis, but there are numerous Review Questions that also cover the quantitative analysis and key concepts. It would be worthwhile to devote time in class to these questions since this chapter is the foundation for many of the chapters that follow. -2 There are five Analyzing Managerial Decisions Scenarios presented in the chapter. The first scenario, -?Marginal Analysis”, is based on determining the relevant costs that should be considered when making decisions. The second scenario, -?Consumer Choice and Graphical Tools II, asks students to graph indifference curves and budget constraints to explain the scenario. This scenario relies on graphical analysis of the problem, not a quantitative analysis. It also highlights the relationship between the economic model and what it represents.

The third scenario, -?Interest Healthcare Corp.. Al asks students to consider the motivations for the workers who are not properly implementing their tasks and how this behavior might be changed. The fourth scenario, -?Risk Aversion versus Risk Tasking”, focuses on differences in behavior due to individuals’ varying levels of risk tolerance. This concept is important since it resurfaces in several chapters throughout the text. The final scenario, -?Consumer Choice”, is located at the end of the chapter after the appendix. This scenario focuses on the quantitative analysis of consumer choice.

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Instructors should review this scenario and determine its relevancy to the course since it involves more complicated mathematical analysis than will e used in the rest of the text. However, instructors whose students have the appropriate mathematical background will likely want to review this scenario. (See the Solutions Manual for the answers to these problems). APPENDIX PROBLEMS 1. Define the following terms: marginal utility, ordinal utility, marginal rate of substitution, equal marginal principle, demand function, substitution effect, income effect, normal good, inferior good, perfect complement, and perfect substitute.

Marginal utility measures the additional utility that is obtained by consuming one additional unit of a good, while holding all other goods constant. Ordinal utility yields the ranking of consumption bundles. Absolute comparisons based on the levels of utility can’t be made. Marginal Rate of Substitution (MRS.) is the absolute value of the slope of an indifference curve. Equal marginal principle (as used in this appendix) is the condition that the marginal utility per dollar is the same for all goods at the optimum.

Demand function expresses the mathematical relation between the quantity demanded for a product (how many units consumers will purchase) and the factors that determine consumer choice (such as prices and income). Substitution effect is the change in the quantity emended of a good when its price changes, holding the prices of other goods and utility constant. 2-3 Income effect is the change in the quantity demanded of a good because of a change in income, holding prices constant. Normal good is a good whose demand increases (decreases) with increases (decreases) in income.

Inferior good is a good whose demand decreases (increases) with increases (decreases) in income. Perfect complements have indifference curves shaped as right angles. In this case, the goods are used in fixed proportions. Perfect substitutes have indifference curve that are shaped as straight lines. In this case the consumer purchases only one of the two goods (unless the slopes of the budget line and indifference curve are the same). Susan Pettiest preferences for coffee (by the pound) and doughnuts (by the dozen), can be characterized as follows: MacAfee = MIX = YE 2.

Multitudinous = Mill = ex. a. If the ratio of relative prices is (Pix/Pay) = 6/3 = 2, and Suntan’s income is $90 per period, what combination of pounds of coffee and dozens of doughnuts will she choose? At Suntan’s optimum: ye/ex. = 2 y = xx (1) Given Suntan’s income: xx + 3 (xx) = 90 Coffee: X = 5 Doughnuts: Y = 20 (from equation 1) b. Now let the ratio of coffee to doughnut prices decline to unity holding the price of doughnuts constant. How does Susan respond to the reduction in the relative price of coffee? 2/ex. = 1 y = xx 2-4 xx + 3 (xx) 90 Coffee: X = 10 Doughnuts: Y 20 Thus, the decline in the price of coffee motivates Susan to increase her consumption of coffee to 10 units (she continues to consume 20 doughnuts) c. Redo parts (a) and (b) for the case of income of $60 per period Redoing part a: xx + 3 (xx) = 60 Coffee: X = 3. 33 Doughnuts: 13. 32 units Redoing part b: xx t 3 (xx) = 60 coffee: X = 6. 66 Doughnuts: Y = 13. 32 units d. Derive Suntan’s demand function for coffee. Y/xx pix/pay (xx)pix (1 ) From the budget line: x (I-pay)/pix (2) Substituting equation (2) into equation (l)and solving for y: Y = 2/3 (I/pay) e.

Is coffee a normal or inferior good for this consumer? Coffee is a normal good for Susan since its consumption increases with income. F. Does Susan consider coffee and doughnuts to be either perfect complements or perfect substitutes? Explain. No they are neither perfect substitutes are complements. Susan does not consume the two goods in fixed proportions (so they are not complements). She also does consume only one good as relative prices hang (so they are not perfect substitutes). The marginal rate Of substitution (y/xx) continuously declines as Susan consumes more x and less y along an indifference curve.

Suntan’s demand function for coffee in the previous problem includes only the price of coffee and income. Thus changes in the price of doughnuts do not affect the demand for coffee. Does this imply that there is no substitution effect between the two goods? Explain. 2-5 3. No. The fact that the price of coffee is not in Suntan’s demand curve for doughnuts does not imply that there is no substitution effect between the two products. With convex indifference curves there is always a positive substitution effect.

The demand curve reflects both the income and substitution effects. Increasing (decreasing) the price of coffee motivates Susan to substitute toward (away from) doughnuts. However, this change in her demand for doughnuts is exactly offset by the income effect from the change in her effective income as the price of coffee changes. 4. Mario Casual is a newscaster who gets an annual clothing allowance to buy suits that he must wear during his televised forecasts. He allocates the allowance each year between expensive Italian suits and cheap American its.

Maria’s utility function for suits is IA. 5 where I is the number of Italian suits bought and A is the number of American suits bought. Last year, Mario bought two Italian suits and four American suits. [Note: MUM A. S and MUM = a. If Mario was maximizing his utility last year, what was the ratio of the price of an Italian suit to the price of an American suit (PI/PA)? At Maria’s optimal choice: MUM/MUM = PI/PA = PI/PA A,’. IS = PI/PA 4/. 5(2) = 4 – PI/PA b. What was Maria’s clothing allowance last year if the price of an Italian suit was SSL ,OHO?

Pl = $ 1000 implies that PA = 5250 (from part a) Clothing allowance = $1 OHO x 2 + $250 x 4 = $3000 2-6 Chapter 02 ; Economists’ View Of Behavior If Mario has the same allowance this year as last year, and American suit prices have not changed, how high would the price of Italian suits have to rise in order for Mario to want to buy exactly one Italian suit this year? As given in the problem, let = From the budget line: $250 x A + Pl x 1 = $3,000 A = 12 – (Pl/250) From the optimal condition stated in part a: (12 – (PI/250)/. 5 = Pl/250 Pl = $2000 (Alternatively, the optimal condition in part a implies that PA . Pl; this implies that Mario will always Penn 1/3rd of his budget on A and 2/3rd if budget on l; thus P = $20TH when the I = 1 and the clothing allowance is $3,000) REVIEW QUESTIONS 2-1. Which costs are pertinent to economic decision making? Which costs are not relevant? The marginal (incremental) costs and benefits are pertinent to economic decision making. Sunk costs and benefits are not relevant. In economics, -?bygones are forever bygones. II 2-7 2-2. A noted economist was asked what he did with his -?free time. II He responded by saying that -?time is not free.

II Explain this response. Time is finite. If it is used for one activity it cannot be used for another activity. Thus using time for one activity involves an opportunity cost (the value Of using the time for the best alternative use). For example, if you spend an hour of time managing your own business when you could have used the hour to earn $20 working for someone else, the opportunity cost of working in your own business is $20/hour. 2-3. The Solace Company has an inventory of steel that it originally purchased for $20,000. It currently has an offer to sell the steel for $30,000.

Should Solace’s management agree to sell? Explain. You cannot answer this question without additional information. The historic cost of the steel is irrelevant. What is important is the current opportunity cost of the steel. For example, if the current market price of steel is $40,000 you should not sell the steel for $30,000. 2-4. Suppose that you have $900 and what to invest the money for one year. There are three existing options. (a) The city of Rochester is selling bonds at $90 per unit. The bonds pay $1 00 at the end of one year when they mature (no other cash flows). B) Put the money under your mattress. (c) The one-year interest rate of saving in the Chase Bank is 7 percent. Which one will you choose? What is the opportunity cost of your choice? Explain. Choose option (a). By definition, opportunity cost is the value of the best foregone option. So the opportunity cost of (a) is the value of (c) in this case, $63 = $900 Suppose Jean’s utility function is given by U = FCC, where F and C are the two goods available for purchase: food and clothing. A. Graph Jean’s indifference curves for the following levels Of utility: 100, 200, and 300. 2-5. -8 Jean’s indifference curves for IS = 100, 200 and 300 are pictured as follows. The general formula for the graph of an indifference curve for a given level of utility, IS*, is (since U* = Fix C). For example, the indifference curve for U* 100 is given by the formula: F = 100/C. B. Are these curves convex or concave to the origin? What does this shape imply about Jean’s willingness to trade food for clothing? The curves are convex to the origin. This implies that Jean’s willingness to trade food for clothing falls when the amount of food that he has declines relative to the amount of clothing.

He is willing to give up a relatively large amount of food for a unit of clothing when he has lots of food and little clothing. This is not rue when he has little food and numerous clothing. C. Suppose Jean’s budget is $100 and the prices of F and C are both $5. The budget constraint. Graph 2-9 Jean’s budget constraint (l = $1 00 and PC = IF = $5) is pictured as follows: d. How many units of food and clothing will Juan purchase at these prices and income? Show graphically. What is his corresponding level of utility? Juan will purchase 10 units of food and 10 units of clothing.

This provides Juan with 100 units of utility. Note that at current prices he can buy a total of 20 units of the two goods (in any combination). Any other combination produces lower utility. For example, 9 units of one good and 11 units Of the Other produces 99 units of utility. Graphically: 2-10 e. The Joy moons Company is the sole producer of clothing. What can the company do to induce Juan to purchase more clothing? Show graphically. (The graph does not have to be exact. ) It can lower the price of clothing. Graphically (does not have to be exact) 2-6.

Suppose that Bob’s indifference curves are straight lines (as opposed to being convex to the origin). What does this imply about Bob’s willingness to trade one good for the other? Give examples of goods where this type of behavior eight be expected? Straight line indifference curves indicate that Bob’s willingness to trade one good for the other does not depend on the amount of each good he currently owns. This is the case of perfect substitutes. Consider the example of $5 bills and $1 0 bills. Your willingness to trade $5 bills for $10 bills is likely to remain at two for one, independent of how many bills of each kind you have.

For example, if you have no $1 0 bills and a bunch Of $5 bills you are still unlikely to trade more than two $5 bills to obtain a $10 bill. Another example is two brands of orange juice that you like equally as ell. Suppose that Bob’s indifference curves are perfectly L;shaped with the right angle occurring when Bob has equal amounts of both goods. What does this imply about Bob’s willingness to trade one good for the other? Give examples of goods where this type of behavior might be expected? 2-7. 2-11 Perfectly L-shaped indifference curves imply that the Bob considers the two goods to be perfect complements.

His utility does not increase if receives more of one of the goods without receiving more of the other good. One potential example is left and right shoes. Obtaining additional left shoes thou obtaining matching right shoes is unlikely to increase a person’s utility very much (assuming the person has two feet). 2-8. A. Briefly describe the five models of behavior presented in this chapter. Economic Model: People are creative maximizes of their own personal happiness (utility). Happiness can depend on many factors, including wealth, integrity, community respect, and so on.

Only-Money-Matters Model: All people care about is money. People act to maximize their monetary income. Same as economic model except that people care only about money. Happy- is-Productive Model: Happy employees are more productive than unhappy employees. Good-Citizen Model: Employees want to do a good job. Managers simply need to communicate the goals and objectives of the organization to the employees. Product-of-the-environment Model: The behaviors of individuals are largely determined by their upbringings. B. What are the implications of these models for managers attempting to influence their employees’ behavior?

The economic model suggests that managers should focus on incentives (monetary or otherwise) in trying to motivate behavior. The only-anemometers model suggests that managers should use only monetary incentives in trying to motivate behavior. The happy-is productive model suggests that productivity can be increased by enriching jobs and engaging in other activities to increase employee happiness. The good-citizen model suggests that managers should focus on communicating firm goals to employees. The product-of-the environment model suggests that managers should focus on hiring employees with a strong work ethic. -12 Chapter 02 2-9. – Economists’ View Of Behavior Employees in a plant in Minnesota are observed to be industrious and very productive. Employees in a similar plant in Southern California are observed to be lazy and unproductive. Discuss how alternative views of human behavior and motivation might suggest different explanations for this observed behavior. The economic model suggests the employees in the two locations have different compensation or incentive schemes. Incentives to be productive appear to be higher at the Minnesota plant.

Or, if the compensation plans are the same, the alternative employment opportunities differ so that individuals with different talents are attracted to the two plants. The only money-matters model is similar to the economic model in its explanation. However, the focus is exclusively on monetary incentives. The pappy-is productive model suggests that employees are happier at the Minnesota plant. The good-citizen model Suggests that employees at the Southern California plant do not realize that it is important to the firm for them to work hard.

The product-of-densitometer model suggests that the employees at the two plants are from different backgrounds. The employees at the Minnesota plant have a stronger work ethic. 2-10. Employees at a department store are observed engaging in the following behavior: (a) they hide items that are on sale from the customers, and (b) they exert little effort in designing merchandise displays. They are also uncooperative with one another. What do you think might be causing this behavior, and what might you do to improve the situation? The employees apparently are paid in a way that motivates this behavior.

For instance, they might be paid a large sales commission on their personal sales. This commission plan might motivate employees to hide items on sale so that they can convince customers to buy higher-priced items. The commission scheme also might provide limited incentives to engage in ensiling activities, such as designing merchandise displays or helping coworkers. It is also likely that employees do not expect to work for the store for a long time period (turnover is high). Otherwise, they would have an incentive to build longer- term relationships with customers (to increase future sales commissions) and co-workers.

The situation might be improved by changing the compensation scheme to increase the incentives to engage in ensiling activities and to consider the long-term implications of an action (such as creating customer expectations that the store will be out of items that are on sale). 2-13 2-?1 1. One of the main tenets of economic analysis is that people act in their wan self interest. Why then do people leave tips in restaurants? If a study were to compare the size of tips earned by servers in restaurants on interstate highways with those in restaurants near residential neighborhoods, what would you expect to find?

Why? When a customer comes into a restaurant in the U. S. They have an implicit contract with the waiter to tip for good service. A customer might honor this contract for two reasons. F-iris, the person might value being fair and not want to shirk on the implicit agreement (economics allows for people to care about fairness). Second, the customer ill realize that if he shirks on the tip the next time he comes back to the restaurant the waiter will shirk on service.

Tips are likely to be higher at restaurants in residential neighborhoods because the second effect (the repeat-customer effect) is likely to be large. Restaurants on interstate highways will be frequented by many customers who will not return. These customers have large incentives to shirk on the tip unless they care significantly about fairness to the waiter. 2-?12. Several school districts have attempted to increase teacher productivity by paying teachers based on the scores their students achieve on denaturized tests (administered by outside testing agencies).

The goal is to produce higher quality classroom instruction. Do you think that this type of compensation scheme will produce the desired outcome? Explain. Compensation plans of this type provide incentives for teachers to emphasize the material covered in the texts. Yet such plans sometimes produce bad side effects. Teachers will have strong incentives to focus on test scores. This focus does not necessarily produce better teaching. In part, it depends on how well the tests measure learning. Moreover, some teachers are likely to discover says to -?game the compensation scheme. L For instance, in some school districts, this type of compensation scheme has motivated teachers to teach the material to be tested rather than provide a more general education. In extreme cases, teachers get advanced copies of the exam and give the answers to students before the test. 2-13. A company recently raised the pay of employees by 20 percent. Employee productivity remained the same.

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