Chapter 20 Consumer
Behavior and Demand Theory
I. Law of diminishing marginal utility
Unit 1 Review
Consuming more within a given period will result
Other Micro Chapters
Micro Test Review 1
covers chapters 19-22
|Number Purchased||Total Utility||Marginal Utility||
II. Utility maximizing rule
|X costs $3||Y costs $2||Z costs $1|
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
Unit 3 Review
Amount consumers are willing
and able to pay
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
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.
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
normal profit, and is a component of the
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 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.
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
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
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
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:
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):
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.
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,
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.
1. Deadweight Loss
2. Tax Incidence and Deadweight Loss
C. Applying Consumer Surplus from Tariffs and Quotas Video from ACDC
Unit 4 Review
Amount producer receives minus what they are
V. Determine Demand
1. Indifference Curve
2. Budget Constraint
3. Expansion Path VI. Normal and Superior Goods
C. With Normal Goods, consumers buy more as income rises,
D. With Inferior Goods, less as income rises.
E Maximizing Behavior from Cyber Economics has a more in depth analysis.
Unit 5 Review
Consumers buy less as income rises
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Inconsistency Among the Elderly
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