Skip to content

IAI Actuarial Core Principles · Business Economics

Consumer Demand and Behaviour for CB2 Business Economics

Consumer demand and behaviour explains how buyers choose what to purchase given prices, income and preferences. You solve it by linking the demand curve to supply for equilibrium, measuring responsiveness with elasticity, and modelling choice with utility, indifference curves and budget lines. Practise drawing clear diagrams and stating assumptions.

What this chapter covers

This chapter covers the demand side of microeconomics. You start with demand, supply and market equilibrium, then measure how demand reacts to price, income and the prices of other goods using elasticities. After that you move to the theory behind the demand curve: utility, indifference curves and budget constraints, and the split of a price change into income and substitution effects.

The chapter ends with consumer surplus and behavioural perspectives. Consumer surplus measures the benefit buyers get over what they pay. Behavioural ideas challenge the assumption that consumers always choose rationally, which links to how people actually buy financial products.

This chapter sits inside Microeconomics, which is the largest topic in the CB2 syllabus at 40% on the 2026 weightings, alongside Macroeconomics at 55% and Economic schools at 5%. Demand and elasticity return in the chapters on firms, market structures, and government intervention. The same supply and demand diagrams are also used in macroeconomic reasoning, so weak foundations here cost you later.

CB2 is a written paper of 3 hours 15 minutes, and it opens with multiple-choice questions before written questions. Demand and elasticity are ideal for both. MCQs test quick calculations and direction of shifts. Written questions reward clear diagrams, correct definitions and applied explanations. The ideas are also reused across the rest of the paper, so time spent here pays back many times. You need at least 50% to pass CB2, and this chapter is one of the more predictable places to collect marks if you practise diagrams and short calculations.

Consumer demand and behaviour: topics in the order to study them

  1. 1Demand, Supply and Market EquilibriumEverything else uses the demand curve and equilibrium, so learn shifts versus movements first.
  2. 2Price, Income and Cross Elasticity of DemandElasticity is a measurable extension of the demand curve and gives you quick calculation marks.
  3. 3Utility Theory and Marginal UtilityIt explains why demand slopes downwards and prepares you for the choice rule in later topics.
  4. 4Indifference Curves and Budget ConstraintsThis is the main model of consumer choice and builds on utility ideas with a diagram.
  5. 5Income and Substitution EffectsIt needs the indifference curve and budget line diagram, so it comes after them.
  6. 6Consumer Surplus and Behavioural PerspectivesIt uses the demand curve and utility ideas, and the behavioural material tests the limits of the rational model.

How to prepare Consumer demand and behaviour

Aim to understand each model well enough to draw it from memory and explain it in words. Short, regular sessions work well on a phone, but diagrams need pen and paper.

  1. Read each topic once for the idea, then write a one-line definition of every key term in your own words.
  2. Draw the core diagrams repeatedly until you can do them without notes: demand and supply shifts, budget line with indifference curves, and income and substitution effects.
  3. Practise elasticity formulas on small numbers. Write the formula, the working and the sign, then say whether demand is elastic, inelastic or unit elastic.
  4. For every diagram, write two or three sentences of explanation. State the assumptions, such as ceteris paribus, rational choice and well-behaved preferences.
  5. Link each topic to an example, such as a fuel price rise or an insurance purchase, so you can apply theory in written answers.
  6. Do past-style MCQs for speed, then attempt written questions under time limits and compare your answers with the marking points.
  7. Revise the behavioural material last and be ready to contrast it with the rational choice model.

Common mistakes in Consumer demand and behaviour

  • Confusing a movement along the demand curve with a shift of the curve.

    Fix: Ask what changed. If it is the good's own price, move along the curve. If it is anything else, shift the curve.

  • Getting the sign or interpretation of elasticity wrong.

    Fix: Compute with the sign, then judge elasticity using its absolute value, and say clearly what the result means.

  • Drawing indifference curves that cross or have no labels.

    Fix: Label both axes, the budget line, the curves and the optimum. Remember that curves cannot cross under standard assumptions.

  • Mixing up income and substitution effects for inferior goods.

    Fix: Treat the two effects separately. For an inferior good, the income effect works against the substitution effect.

  • Stating the utility maximising condition without its conditions.

    Fix: State that it applies to well-behaved preferences with an interior solution, and explain MRS equal to the price ratio in words.

  • Treating behavioural ideas as a list of terms with no application.

    Fix: For each bias, give a short example and explain how it departs from rational choice.

Last-day revision: Consumer demand and behaviour

  • A change in the good's own price moves along the demand curve; a change in income, tastes or related prices shifts the curve.
  • At equilibrium, quantity demanded equals quantity supplied; a price above it gives a surplus and below it a shortage.
  • Price elasticity of demand = % change in quantity demanded ÷ % change in price; it is usually negative, and is often quoted in absolute value.
  • Demand is elastic if |elasticity| > 1, inelastic if < 1 and unit elastic if = 1.
  • Income elasticity is positive for normal goods and negative for inferior goods.
  • Cross elasticity is positive for substitutes and negative for complements.
  • Marginal utility is the extra utility from one more unit and is assumed to diminish.
  • A consumer maximises utility where the marginal rate of substitution equals the price ratio, for well-behaved preferences with an interior solution.
  • The budget line shifts in parallel when income changes and pivots when one price changes.
  • Indifference curves slope downwards, do not cross and are convex to the origin under standard assumptions.
  • A price fall has a substitution effect and an income effect; for a normal good both raise quantity demanded.
  • Consumer surplus is the gap between what buyers are willing to pay and what they pay; behavioural economics adds biases such as framing and loss aversion.

Consumer demand and behaviour practice questions

Consumer demand and behaviour in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Consumer demand and behaviour: frequently asked questions

How much of CB2 does this chapter cover?

This chapter belongs to Microeconomics, which carries 40% in the 2026 syllabus weightings. The exact share of questions varies by session, so prepare all topics.

Do I need calculus for consumer theory in CB2?

Most of the chapter can be handled with diagrams, simple arithmetic and clear explanation. Check the current syllabus and past papers for the level of mathematical working expected.

What is the best way to learn the income and substitution effects?

Redraw the budget line and indifference curve diagram until it is automatic. Then label the substitution effect first and the income effect second, and explain each in a sentence.

Can I study this chapter on my phone?

You can learn definitions, formulas and revision points on a phone. For diagrams, practise on paper so you build the drawing skill the written paper needs.