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Chapter 20

  Consumer Behavior and Demand Theory

Election Issues center on economics.

Economists Critique America's Education 

 

I. Special Notes:  Our Current Events Internet Library has an interesting economics section.

II. Satisfaction received and limited budgets determine consumer demand.

III. Utility analysis
      A. Law of diminishing marginal utility
          1. Utility measures the want-satisfying power of a good or service.
          2. Marginal utility is the additional or incremental satisfaction (utility) a consumer receives from acquiring
              one additional unit of a product.
          3. Law of diminishing marginal utility: Consuming more of a product within a given period will at some
              point result in diminishing marginal utility. 
               a. Disutility results when total satisfaction decreases with the consumption of an additional unit. 
               b. A person can eat only so many hot dogs before they get sick. 
               c. 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.
               d. A util is a fictitious measure of satisfaction. Two utils have twice the satisfaction of one util.

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. Can you give a formula for the utility of different products and different people. Use fake names like PopPie for a friend who works out all the time and each hour and each day is equally as enjoyable.

E-Mail Professor A with your thoughts.

Number Purchased Total Utility Marginal Utility

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

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

          2. 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  

           3. Econ Concepts in 60 Seconds Utility Maximizing Video
      C. 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.
     D. Consumer's surplus
         1. All goods are purchased at an equilibrium price. 
         2. Because consumers would have paid more for smaller quantities purchased, they are said to receive a surplus.  
     E. Extra Credit Barry Schwartz on the paradox of choice or   Malcolm Gladwell on spaghetti sauce from TED

IV. 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 a  land.

Overview

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 labour.

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 alternatingly 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.

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)

       where:

  • 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
     1.  Reference  Friedman, David D. Price Theory: An Intermediate Text - Chapter 9
     2. Further Reading Henry George, Progress and Poverty [1]
Editors note: And now back to Quick Notes
V. 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 Using Tariffs and Quotas Video from ACDC Economics

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VI. Normal Goods, consumers buy more as income rises, Inferior Goods, lest as income rises.

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

 VII.  Behavioral Economics has drawn more interest of late.
VIII.  Our Economics Learning Center is for students, teachers, and professionals.
   IX.  Marginal utility - Wiki  has more info.

 

Suggest something of Interest  to 

 Professor A  

How about some Normal and Inferior Goods.

Is Adam Sandler Normal?

What goods will you buy less of as you get rich?

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