Demand: the Benefit Side of the Market
The law of demand states that the quantity demanded of a good or service in a given time period declines as its price increases, ceteris paribus. Demand is a result of people’s wants for satisfaction. Utility is a measure of the satisfaction or happiness people get from their consumption activities, measured by an abstract unit “utils”. Utility maximisation is then the assumption that rational people try to allocate their incomes so as to maximise their utility. Marginal utility is the additional utility gained from consuming an additional unit of a good in a given period
The law of diminishing marginal utility is the tendency for additional utility gained from consuming an additional unit of a good in a given time period to diminish as consumption increases beyond a certain point. By this law, marginal utility will become negative at some point.
Allocation of Fixed Income between Two Goods
Law of diminishing marginal utility imply that spending it all on a single good is not a good idea. Instead, rational people should aim for the optimal combination of goods, i.e. the affordable combination of goods that yields the highest total utility, in order to maximise utility.
To do so, we follow the rational spending rule, which states that spending should be allocated across goods and services so that the marginal utility per dollar is the same for each good.
Demand and Consumer Surplus
Consumer surplus is the difference between a buyer’s reservation price (the maximum price they are willing to pay) for a good and the price actually paid. On a demand curve, the consumer surplus is the area that lies between the demand curve and the market price.
E.g. in the oil market, the equilibrium price and quantity is $2 and 4000 gallons a day respectively. All the customers whose reservation price is more than $2 is therefore receiving consumer surplus. For all these buyers, the consumer surplus is the cumulative difference between their reservation prices and the prices they actually paid
