Consumer Behavior and Demand Theory

Consumer Behavior

• Rational Choice Theory: assumes consumers make rational decisions to maximize their utility (satisfaction) given their budget constraint
• Budget Constraint: a graphical representation of the combinations of two goods that a consumer can afford to buy
• Indifference Curves: show different combinations of two goods that provide the same level of utility
• Demand Theory: studies how consumer behavior responds to changes in price and income
• Law of Diminishing Marginal Utility: the additional utility gained from consuming one more unit of a good decreases as the quantity consumed increases

Market Equilibrium

• Market Equilibrium: a state where the quantity of a good or service that consumers are willing to buy (demand) equals the quantity that producers are willing to supply
• Equilibrium Price: the price at which the demand and supply curves intersect
• Surplus: a situation where the quantity supplied exceeds the quantity demanded
• Shortage: a situation where the quantity demanded exceeds the quantity supplied
• Adjustments to Equilibrium: changes in price and quantity in response to changes in demand or supply

Supply and Demand

• Law of Supply: as the price of a good increases, the quantity supplied also increases, ceteris paribus
• Law of Demand: as the price of a good increases, the quantity demanded decreases, ceteris paribus
• Supply Curve: a graphical representation of the relationship between price and quantity supplied
• Demand Curve: a graphical representation of the relationship between price and quantity demanded
• Shifts in Supply and Demand: changes in the supply or demand curve in response to changes in factors other than price

Production Theory

• Firm's Objective: to maximize profits by minimizing costs and maximizing revenue
• Production Function: a mathematical representation of the relationship between inputs (labor and capital) and output
• Marginal Product: the additional output generated by one additional unit of a variable input (e.g. labor)
• Marginal Cost: the additional cost generated by one additional unit of output
• Average Cost: the total cost divided by the total output
• Economies of Scale: reductions in average cost as the firm increases its scale of production

Consumer Behavior

• Consumers make rational decisions to maximize their utility (satisfaction) given their budget constraint, based on the Rational Choice Theory
• Budget Constraint is a graphical representation of the combinations of two goods that a consumer can afford to buy
• Indifference Curves show different combinations of two goods that provide the same level of utility
• Demand Theory studies how consumer behavior responds to changes in price and income
• Law of Diminishing Marginal Utility states that the additional utility gained from consuming one more unit of a good decreases as the quantity consumed increases

Market Equilibrium

• Market Equilibrium occurs when the quantity of a good or service that consumers are willing to buy (demand) equals the quantity that producers are willing to supply
• Equilibrium Price is the price at which the demand and supply curves intersect
• Surplus occurs when the quantity supplied exceeds the quantity demanded
• Shortage occurs when the quantity demanded exceeds the quantity supplied
• Adjustments to Equilibrium involve changes in price and quantity in response to changes in demand or supply

Supply and Demand

• Law of Supply states that as the price of a good increases, the quantity supplied also increases, ceteris paribus
• Law of Demand states that as the price of a good increases, the quantity demanded decreases, ceteris paribus
• Supply Curve is a graphical representation of the relationship between price and quantity supplied
• Demand Curve is a graphical representation of the relationship between price and quantity demanded
• Shifts in Supply and Demand occur in response to changes in factors other than price

Production Theory

• A firm's objective is to maximize profits by minimizing costs and maximizing revenue
• Production Function is a mathematical representation of the relationship between inputs (labor and capital) and output
• Marginal Product is the additional output generated by one additional unit of a variable input (e.g. labor)
• Marginal Cost is the additional cost generated by one additional unit of output
• Average Cost is the total cost divided by the total output
• Economies of Scale refer to reductions in average cost as the firm increases its scale of production

Test your understanding of consumer behavior, including rational choice theory, budget constraints, indifference curves, and demand theory.