Chapter 3

DEMAND

Definitions and Concepts of Demand

Demand: The amount of a good or service that a consumer is WILLING and ABLE to buy during a given period of time. Effective demand

Definitions and Concepts of Demand

Quantity Demanded – the amount of a good or service that a consumer is willing and able to buy at EACH particular price during a given period of time.

Definitions and Concepts of Demand

Law of Demand – As prices go down, quantity demanded goes up. INVERSE

RELATIONSHIP

Substitution Effect

Tendency of consumers to substitute a similar, lower priced product for another product that is more expensive.

Butter for margarine Chicken for steak Plain label for name brand

Substitution Effect

Explains why a higher price causes a decrease in the quantity demanded.

Substitution Effect

BUT: If a good is seen as

essential and there is no readily available substitute –

People will continue to buy the same amount. Gas? Milk? Coke v. Pepsi?

Income Effect

Purchasing Power: The amount of money available to spend on goods and services.

BUT: any increase or decrease in consumers’ purchasing power caused by a change in price is the INCOME EFFECT

Income Effect

Homers lowers the price of CDs from $15 to $10 – the consumer can buy more CDs with the same amount of income.

Income Effect in Reverse

The price of the CDs jumps to $20 and a consumer with $30 to spend, can now only buy one. Purchasing power is

down.

Income Effect

Strong and predictable influence on the quantity demanded. BUT: Consumers may

be ABLE to buy 3 CDs at $10, but they may still only be WILLING to buy 2. EFFECTIVE demand

Definitions and Concepts

Diminishing Marginal Utility – DMU: Usefulness of a product (utility).

Typically utility goes up as more product is consumed.

BUT: More units may be consumed, but satisfaction diminishes with more and more consumption

Demand Schedule

Shows quantities demanded at VARIOUS prices on a schedule.

Demand Curve

Shows all prices and quantities demanded in a graph.

Demand Curve Changes

Increases in demand move the curve to the right.

What Changes Demand?

Tastes and Preferences Income Market Size Consumer expectations Price of related goods

Complements Substitutes

Substitute Goods

Goods that can be used to replace the purchase of similar goods when prices rise.

Complementary Goods

Goods that commonly used with other goods.

If paint goes on sale, the demand for paintbrushes goes up.

McDonalds meals

Consumer Expectations

Expectations of future income cause shifts in demand. Income goes up with a

promotion / new job. Expecting to lose your

job – tighten up and demand less.

Elasticity of Demand

People buy more at lower prices.

BUT We respond to some

sales more than others.

Elasticity = Responsiveness

Certain goods tend to have ELASTIC demand if: The product is NOT a

necessity. There are readily

available substitutes Products cost represents

a large portion of consumer income.

Elasticity = RESPONSIVENESS

A SMALL decrease in a good’s price causes a SIGNIFICANT increase in the quantity demanded.

ELASTIC DEMAND

Pizza is considered ELASTIC DEMAND.

It is NOT a necessity. Readily available substitutes. Cost of the product

compared to consumers’ income.

For you, a sale on pizza is a bigger deal than for adults with full time jobs.

Elastic Demand

Curves tend to be FLATTER if demand is ELASTIC.

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Inelastic Demand = Unresponsive

Inelastic Demand exists when a change in a good’s price has LITTLE impact on the quantity demanded.

Inelastic Demand = Unresponsiveness

Inelastic Demand IF Product is a necessity There are few or no

readily available substitutes for the product

The product’s costs represents a small portion of consumer’s income.

Inelastic Demand Products

Salt Soap Insulin Gas

REMEMBER!

Inelastic Demand curves tend to be more vertical.

IIIIIII

Insulin

Measuring Elasticity

Business people need to be able to measure demand elasticity for their goods and services.

Measuring Elasticity

Total Revenue Test Total Revenue = total

income the business receives from selling its products. Sometimes called total

receipts.

Measuring Elasticity

By measuring any changes in a business’s total revenue before and after changes in the price of a product you can determine elasticity of demand for the product.

Total Revenue and Elastic Demand

A drop in a business’s total revenue from a price increase indicates elastic demand.

Changing movie ticket prices from $4 to $5.

Total Revenue and Inelastic Demand

A rise in a business’s total revenue because of a price increase indicates inelastic demand. Say the ticket prices

went from $3 to $4.

Maximizing Total Revenue – When did the theater get the

maximum profit?

NON PRICE Determinants of Demand

New advertisements Government policy

decisions Taxing imports or

adding sales taxes

Changes of technology.

Questions to Answer

Define elasticity of demand. Define Elastic Demand Define Inelastic Demand Define total revenue. Can you name items with elastic demand?

Inelastic demand?

Questions to answer

Why is determining demand elasticity important in economics?

How can a product have both elastic and inelastic demand? Example not used in book???