Demand &

Consumer Behavior
Chapter 5

Topics
Choice & utility theory
Cardinal utility
Ordinal utility
Demand theory

From individual to market demand

Applications
Economics of addiction
Paradox of value
Consumer surplus

Chapter 5
Table 5-1

Chapter 5
Figure 5-1

The Law of Diminishing

Marginal Utility

Deriving the demand curve

Utility maximization basic premise
Equimarginal principle
Equal marginal utilities per peso for every
good
Needed for utility maximization

Price and quantity demanded inverse

relationship

Equimarginal Principle
MUgood 1 MUgood 2

.....
P1
P2

Market demand
Market demand: horizontal sum of
individual demand curves
Demand shifts
Income changes
Normal goods
Inferior goods

Substitutes & complements

Chapter 5
Figure 5-2

Market Demand Derived from

Individual Demands

Chapter 5
Figure 5-3

Demand Curve Shifts with Changes

in Income or in Other Goods Prices

Key concepts
Substitution effect
Income effect
Elasticity
Price elasticity
Income elasticity

Substitutes
Complements
Independents

Some applications
Economics of addiction
Paradox of value
Consumer surplus

Chapter 5
Table 5-2

Chapter 5
Figure 5-4

Demand for Addictive Substances

by Hard-Core Users

Chapter 5
Figure 5-5

Demand for Addictive Substances

by Casual Users

Chapter 5
Figure 5-6

Because of Diminishing Marginal Utility,

Consumers Satisfaction Exceeds What Is Paid

Chapter 5
Figure 5-7

Total Consumer Surplus Is the Area under

the Demand Curve and above the Price Line

Chapter 5
Table 5-3

Economic Rationality
The principal behavioral postulate is that a
decisionmaker chooses its most preferred
alternative from those available to it.
The available choices constitute the
choice set.
How is the most preferred bundle in the
choice set located?

Rational Constrained Choice

x2

x1

Rational Constrained Choice

Utility

x2

x1

Rational Constrained Choice

Utility

x2

x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility
Affordable, but not
the most preferred
affordable bundle.
x2
x1

Rational Constrained Choice

Utility

The most preferred

of the affordable
bundles.
Affordable, but not
the most preferred
affordable bundle.

x2
x1

Rational Constrained Choice

Utility

x2
x1

Rational Constrained Choice

Utility
x2
x1

Rational Constrained Choice

x2
Utility

x1

Rational Constrained Choice

x2

Utility

x1

Rational Constrained Choice

x2

x1

Rational Constrained Choice

x2

Affordable
bundles

x1

Rational Constrained Choice

x2

Affordable
bundles

x1

Rational Constrained Choice

x2

More preferred
bundles

Affordable
bundles

x1

Rational Constrained Choice

x2
More preferred
bundles

Affordable
bundles
x1

Rational Constrained Choice

x2

x2*

x1*

x1

Rational Constrained Choice

x2

(x1*,x2*) is the most

preferred affordable
bundle.

x2*

x1*

x1

Rational Constrained Choice

The most preferred affordable bundle is
called the consumers ORDINARY
DEMAND at the given prices and budget.
Ordinary demands will be denoted by
x1*(p1,p2,m) and x2*(p1,p2,m).

Rational Constrained Choice

When x1* > 0 and x2* > 0 the demanded
bundle is INTERIOR.
If buying (x1*,x2*) costs $m then the
budget is exhausted.

Rational Constrained Choice

x2

(x1*,x2*) is interior.
(x1*,x2*) exhausts the
budget.

x2*

x1*

x1

Rational Constrained Choice

x2

(x1*,x2*) is interior.
(a) (x1*,x2*) exhausts the
budget; p1x1* + p2x2* = m.

x2*

x1*

x1

Rational Constrained Choice

x2

x2*

(x1*,x2*) is interior .
(b) The slope of the indiff.
curve at (x1*,x2*) equals
the slope of the budget
constraint.

x1*

x1

Appendix 5A
Figure 5A-1

Indifference Curves for a Pair of

Goods

Appendix 5A
Figure 5A-2

A Family of Indifference Curves

Appendix 5A
Figure 5A-3

Income Constrains Consumer

Spending

Appendix 5A
Figure 5A-4

Consumers Most Preferred and

Feasible Consumption Bundle Is
Attained at B

Appendix 5A
Figure 5A-5

Effect of Income Change on

Equilibrium

Appendix 5A
Figure 5A-6

Effect of Price Change on

Equilibrium