Chapter 20 Consumer Behavior and Demand Theory

Updated 12/14/16              Please 

Index   I. Law of diminishing marginal utility    II. Utility maximizing rule  2 videos    III. Consumer's surplus  4 videos   IV. Consumer/Producer Surplus  2 videos

V. Normal and Superior Goods VI Readings     Back to Table of Contents  Please 

I. Law of diminishing marginal utility
   A. Satisfaction received and limited budgets determine consumer demand.
     B. Utility measures the want-satisfying power of a good or service.
     C. Marginal utility is the additional or incremental satisfaction (utility) 
          a consumer receives from acquiring one additional unit of a product.
     D. Law of diminishing marginal utility: Consuming more of a product
          within a given period will at some point result in diminishing marginal utility. 
          1. Disutility results when total satisfaction decreases with the consumption of an additional unit. 
          2. A person can eat only so many hot dogs before they get sick. 
          3. A potato chip company had an ad that said "I bet you can't eat one."
              The idea was that utility went up and you had to eat more than one chip.
          4. A util is a fictitious measure of satisfaction. Two utils have twice the satisfaction of one util.
          5. Educating the Class of 2034 applies diminishing utility theory to education.
     E. Utility affects the law of demand. 
         1. Because utility diminishes, consumers will not purchase more of a good unless price is
             lowered (law of demand).
         2. The law of diminishing marginal utility causes a demand curve to have a negative slope.
    F. Marginal utility - Wiki  has more info.

Unit 1 Review Consuming more within a given period will result
 in diminishing satisfaction measured as marginal utility.

Other Micro Chapters
21) How Cost of Production Affects Supply

22) Analyzing Profit 

Part II Overview

23) Pure Competition

24) Monopoly

25 Monopolistic Competition

6) Oligopoly

Micro Test Review 1 covers chapters 19-22

Number  Purchased Total Utility Marginal Utility


0 0 0
1 4 4
2 7 3
3 8 1
4 8 0
5 7 -1


II. Utility maximizing rule
    A. When spending a limited amount of money, consumers
        try to equate the marginal utility per dollar for the items
        being purchase.

          B. Given a budget of $15.00, use utility maximizing
               theory to calculate how many of the following
               three products would be purchased assuming
               utility is to be maximized and all the money
               is to be spent.

X costs $3 Y costs $2 Z costs $1
Quantity MUQ MU/$ Buy Quantity MUQ MU/$ Buy Quantity MUQ MU/$ Buy
1 12 4.0 1st 1 6 3.0 3rd 1 3 3.0 3rd
2 10 3.3 2nd 2 4 2.0 4th 2 2 2.0 4th
3 6 2.0 4th 3 1 0.5   3 1 1.0  
4 0 0.0   4 0 0.0   4 0 0.0  

      D. Videos

           1. Econ Concepts in 60 Seconds Utility Maximizing
           2. Practice Problems

Unit 2 Review When spending a limited amount of money, consumers equate the marginal utility per dollar for the items being purchase.

III. Consumer's surplus
       A. All goods are purchased at an equilibrium price. 
       B. Because consumers would have paid more for 
           smaller quantities purchased, they are said to
           receive a surplus. 

       C. Videos
            1. Calculating Consumer Surplus        
            2. Consume Surplus Practice Problems

       D. Extra Credit
           1. Barry Schwartz on the paradox of choice
           2. Malcolm Gladwell on spaghetti sauce from TED
           3. Discussion Question
               I always envy people that have something in
               life for which they have no diminishing utility.
               Do you know anyone? What was the product.
               If they are young, do you think their utility
               function will stay constant.

Unit 3 Review Amount consumers are willing and able to pay
minus the total amount that they actually do pay.

E. More on Economic surplus From Wikipedia, the free encyclopedia. The term surplus is used in economics for several situations. The consumer surplus (sometimes named consumer's surplus or
consumers' surplus) is the amount that consumers benefit by being able to purchase a product for a price that is less than they would be willing to pay. The producer surplus is the amount that producers benefit by selling at a market price mechanism that is higher than they would be willing to sell for.
Note that producer surplus generally flows through to the owners of  the 

  factors of production: in perfect competition, no producer surplus accrues to the individual firm. This is the same as saying that economic profit is driven to zero. Real-world businesses generally own or control  some of their inputs, meaning that they receive the producer's surplus due to them: this is known as normal profit, and is a component of the firm's opportunity costs. If the markets for factors are perfectly competitive as well, producer surplus ultimately ends up as economic  rent to the owners of scarce inputs such as land.    





On a standard supply and demand (S&D) diagram, consumer surplus (CS) is the triangular area above the price level and below the demand curve, since intramarginal 
consumers are paying less for the item than the maximum that they would pay. In contrary, producer surplus (PS) is the triangular area below the price level and above the supply curve, since that is the minimum quantity a producer can produce.

If the government intervenes by implementing, for example, a tax or a subsidy, then the graph of supply and demand becomes more complicated and will also include an area that represents government surplus.

Combined, the consumer surplus, the producer surplus, and the government surplus (if present) make up the social surplus or the total surplus. Total surplus is the 
primary measure used in welfare economics to evaluate the efficiency of a proposed policy.

A basic technique of bargaining for both parties is to pretend that their surplus is less than it really is: sellers may argue that the price they ask hardly leaves them any 
profit, while customers may play down how eager they are to have the article.

In national accounts, operating surplus is roughly equal to distributed and undistributed pre-tax profit income, net of depreciation.

In some schools of heterodox economics, the economic surplus denotes the total income which the ruling class derives from its ownership of scarce factors of production,
which is either reinvested or spent on consumption.

In Marxian economics, the term surplus may also refer to surplus value, surplus product and surplus labor.

Consumer surplus

The individual consumer surplus is the difference between the maximum total price a consumer would be willing to pay (or reservation price) for the amount he buys and
the actual total price. If someone is willing to pay more than the actual price, their benefit in a transaction is how much they saved when they didn't pay that price. For example, a person is willing to pay a tremendous amount for water since he needs it to survive, however since there are competing suppliers of water he is able to 
purchase it for less than he is willing to pay. The difference between the two prices is the consumer surplus.

The maximum price a consumer would be willing to pay for a given amount is the sum of the maximum price he would be willing to pay for the first unit, the maximum 
additional price he would be willing to pay for the second unit, etc. Typically these prices are decreasing; in that case they are given by the individual demand curve. If these prices are first increasing and then decreasing there may be a non-zero amount with zero consumer surplus. The consumer would not buy an amount larger 
than zero and smaller than this amount because the consumer surplus would be negative. The maximum additional price a consumer would be willing to pay for each additional unit may also alternating be high and low, e.g. if he wants an even number of units, such as in the case of tickets he uses in pairs on dates. The lower values
 do not show up in the demand curve because they correspond to amounts the consumer does not buy, regardless of the price. For a given price the consumer buys 
the amount for which the consumer surplus is highest.

One bargaining tactic is to pretend a lower consumer surplus.  The aggregate consumers' surplus is the sum of the consumer's surplus for each individual consumer. This can be represented on the figure of the aggregate demand curve.

  1.  Friedman, David D. 
Price Theory: An Intermediate Text
- Chapter 9
and 2. Further Reading Henry George, Progress and Poverty [1]


Calculation from supply and demand

The consumer surplus (individual or aggregated) is the area under the (individual or aggregated) demand curve and above a horizontal line at the actual price (in the  aggregated case: the equilibrium price). If the demand curve is a straight line, the consumer surplus is the area of a triangle:

CS = \frac{1}{2} Q_{mkt} \left( {P_{max} - P_{mkt}} \right)

Where Pmkt is the equilibrium price (where supply equals demand), Qmkt is the total quantity purchased at the equilibrium price and Pmax is the price at which the quantity purchased would fall to 0 (that is, where the demand curve intercepts the price axis). For more general demand and supply functions, these areas are not triangles but can still be found using integral calculus. Consumer surplus is thus the definite integral of the demand function with respect to price, minus the definite integral of the constant function D(P)=Qmkt (i.e. PmktQmkt), from the market price to the maximum reservation price (i.e. the price-intercept of the demand function):

CS = (\int_{P_{max}}^{P_{mkt}} D(P)\, dP)-P_{mkt}D(P_{mkt})

The graph shows, that if we see a rise in the equilibrium price and a fall in the equilibrium quantity, then consumer surplus falls.

Distribution of benefits when price falls

When supply of a good expands, the price falls (assuming the demand curve is downward sloping) and consumer surplus increases. This benefits two groups of people.
Consumers who were already willing to buy at the initial price benefit from a price reduction; also they may buy more and receive even more consumer surplus, and additional consumers who were unwilling to buy at the initial price but will buy at the new price and also receive some consumer surplus.

Consider an example of linear supply and demand curves. For an initial supply curve S0, consumer surplus is the triangle above the line formed by price P0 to the demand line (bounded on the left by the price axis and on the top by the demand line). If supply expands from S0 to S1, the consumers' surplus expands to the triangle above P1 and below the demand line (still bounded by the price axis). The change in consumer's surplus is difference in area between the two triangles, and that is the consumer welfare associated with expansion of supply.

Some people were willing to pay the higher price P0. When the price is reduced, their benefit is the area in the rectangle formed on the top by P0, on the bottom by P1, on the left by the price axis and on the right by line extending vertically upwards from Q0.

The second set of beneficiaries are consumers who buy more, and new consumers, those who will pay the new lower price (P1) but not the higher price (P0). Their additional consumption makes up the difference between Q1 and Q0. Their consumer surplus is the triangle bounded on the left by the line extending vertically upwards from Q0, on the right and top by the demand line, and on the bottom by the line extending horizontally to the right from P1.

Rule of one-half

The rule of one-half estimates the change in surplus for small changes in supply with a constant demand curve. Note that in this special case where the consumer demand curve is linear, consumer surplus is the area of a triangle. Following the figure above,

\Delta CS = \frac{1}{2} \left( {Q_1  + Q_0 } \right)\left( {P_0  - P_1 } \right)


  • CS = Consumers' Surplus
  • Q0 and Q1 are the quantity demanded before and after a change in supply
  • P0 and P1 are the prices before and after a change in suppl
Editors note: And now back to Quick Notes
IV. Consumer's and Producer's Surplus

       A) Econ Concepts in 60 Seconds Video on Consumer's and Producer's Surplus  
       B) Allocation efficiency exists at the equilibrium quantity and at other quantities, 
           there are efficiency losses or Deadweight Loss.

     C. Applying Consumer Surplus from
       Tariffs and Quotas Video from ACDC 

Unit 4 Review Amount producer receives minus what they are
 willing and able to sell product to customers.

Interesting Sites

2015 Political Controversies 
examine poverty, middle class stagnation, 
politics and capitalism.

Library of Economics and Liberty

Ayn Randlexicon

Mises Institute

Roubini Global Economics

Top 100 Economics Blogs


V. Normal and Superior Goods
  A. Normal Goods, consumers buy more as income rises,
B. Inferior Goods, less as income rises.

      C. Maximizing Behavior from Cyber Economics has a more
          in depth analysis.

Unit 5 Review Consumers buy less as income rises bread) and
 buy more as income rises



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VI Readings

Choice Inconsistency Among the Elderly

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