3.2 Building Demand and Consumer Surplus
Learning Objectives
By the end of this section, you will be able to:
- Explain quantity demanded, and the law of demand
- Identify a demand curve
- Calculate consumer surplus given a Marginal Benefit curve and price
The Law of Demand
Economists use the term demand to refer to the amount of some good or service consumers are willing and able to purchase at each price. Demand is based on needs and wants, and while consumers can differentiate between a need and a want, from an economist’s perspective, they are the same thing. Demand is also based on ability to pay. If you cannot pay for it, you have no effective demand. This concept of a consumer’s willingness to pay (WTP) serves as a starting point for the demand curve. A consumer’s Willingness to Pay is equal to that consumer’s Marginal Benefit (MB). This is useful information if we want to use Marginal Analysis.
As we learned in Topic 1, Marginal Analysis or “thinking on the margin” is how consumers decide whether or not to buy an additional unit. It is the process of considering the additional benefits and costs of an activity to make a decision. Therefore, when we say a consumer is willing to pay x dollars for another good, we are stating that the consumer believes they will receive x amount of benefit. As long as the consumer’s marginal benefit is greater than their marginal cost, they will purchase the good. Therefore, the maximum amount a consumer is willing to pay is equal to their marginal benefit.
What a buyer pays for a unit of a good or service is called price. The total number of units purchased at that price is called the quantity demanded. A rise in price of a good or service will almost always decrease the quantity demanded of that good or service. Conversely, a fall in price will increase the quantity demanded. Economists call this inverse relationship between price and quantity demanded the law of demand. The law of demand assumes that all other variables that affect demand (to be explained in Topic 4) are held constant.
Let’s look at these concepts in more detail with an example. Assume that your car holds 50L of gas and that at the average price of gas you would generally use about a tank of gas each month. This amount allows you to comfortably drive to school and back, run errands, and use the car on weekends for trips. As discussed above, this usage will change as price changes.
Demand Schedules and Curves
As a student on a tight budget, the price of gas will have a large influence on the amount you drive. When the price of gasoline goes up, you will look for ways to reduce your driving by combining errands, commuting by carpool or transit, biking and walking more, and driving less on weekends and holidays. So, what would happen if the price of gas was $3.5/litre? Though you would likely be outraged that prices had risen so high, would you stop driving altogether? Perhaps, but perhaps not. Assuming there are some cases where your margin