Demand

Demand

– The desire to own something, and the ability to pay for it.

• The Law of Demand– As prices go up quantity demanded goes down.– As prices go down quantity demanded goes up.

Demand Curve

• The demand curve is a downward sloping line showing the inverse relationship between quantity and price

Demand Schedule

Market Demand

• Demand curves can show the demand for an individual, or for a “market” of any defined size (classroom, CPHS, Pleasant Hill, etc.)

Substitution Effect

• The substitution effect takes place when there is a similar product which can be substituted if the price of the original product becomes too high.– Butter vs. Margarine– Coke vs. Pepsi (or any other soda, drink)

Income Effect

• As income rises, demand for “inferior” products goes down, while demand for superior products rise.

• Wal-Mart vs. Bloomingdales

• Generic products versus Name brands

Shifts in demand

• Shifts in demand come from changes other than the change in price

• Changing technology• Seasonal changes• Good or bad news• Income and inferior goods• Consumer expectations• Population• Consumer taste and

Advertising• Substitute and

Complimentary goods

Elasticity of Demand

• Elasticity of demand is a concept dealing with the changes in demand due to price changes.

• The amount of change of demand versus the amount of change of price determines elasticity.

• If the change of demand is small, then the demand is called inelastic.

• If the change in demand is large, then demand is called elastic, like a rubber band.

Calculating Elasticity• Elasticity is calculated by looking at the percentage change

in demand over the percentage change in price.

• If the result is less than one, the product is considered inelastic. E < 1

• If the number is over one, the product is considered elastic. E > 1

• If the number is exactly one, the elasticity is considered unitary elastic. E = 1

P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in p rice

2 1 2 1

2 1 2 1

( ) /[( ) / 2]Price elasticity of demand =

( ) /[( ) / 2]

Q Q Q Q

P P P P

Computing the Price Elasticity of Demand• If the price in this graph changes from $5 to $4, quantity

demanded will change from 50 to 100.

• This means that this section of the curve is elastic.

Demand is price elastic.

3percent 22

percent 67

5.00)/2(4.005.00)(4.00

50)/2(10050)(100

ED

$5

4Demand

Quantity1000 50

Price

Inelastic Demand

• Inelastic demand is demand that changes little when the price changes. This kind of demand is usually considered a necessity, true for products like urgently needed medicines, energy, gasoline, or milk for children.

• Inelastic demand changes from person to person, depending of what each person considers a necessity, or a luxury. For some, cell phones might be considered an inelastic product.

• If private enterprise controls the market for inelastic goods, is this a good thing? Consider water and electricity.

Figure 1 The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity0

$5

90

Demand1. A 22%increasein price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100

Elastic Demand

• Demand for a product is considered elastic if the demand drops sharply when price increases.

• Elastic products are considered “luxuries”, where spending on them is not a priority.

• Items like seeing a movie or “fashionable” cloths would be more elastic than many other items.

Figure 2 The Price Elasticity of Demand

(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

1000

Price

$5

50

1. A 22%increasein price . . .

2. . . . leads to a 67% decrease in quantity demanded.

Unitary Elasticity

• Unitary elasticity is when the percentage change in price equals the percentage change in quantity.

• Sellers like this range because it is usually the region of maximum profit.

Figure 3 The Price Elasticity of Demand

2. . . . leads to a 22% decrease in quantity demanded.

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

$5

80

1. A 22%increasein price . . .

Demand

Extreme Conditions of Elasticity

• Sometimes demand for items is very elastic or very inelastic.

• A very elastic curve is almost flat.

• A very inelastic curve is almost vertical

Figure 4 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,consumers willbuy any quantity.

1. At any priceabove $4, quantitydemanded is zero.

3. At a price below $4,quantity demanded is infinite.

Figure 5 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

Factors that affect Elasticity

• Availability of substitutes

• Relative importance

• Necessity or Luxury

• Time – Over a longer period of time, elasticity increases

Changes Over Time

• When prices change, it can take some time before a substitute is found, thus leading to inelasticity over the short term.

• As time increases, elasticity increases as substitutes are found.

• For example, if gas prices rise enough, you might consider using public transport instead, though you may need to research which bus or rail connections will cover your needs.

Elasticity and Pricing

• If a business knows it’s product is inelastic, it knows it can raise it’s price without much loss in demand.

• There is another side to the issue though, as a business might need to be careful about it’s company image. Consider the case of Cochabamba in Boliva, Bechtel, and the water supply (in “The Corporation”).