DemandEssential Question:

What determines what we buy?

Unit 2The Elements of a Market

Economy

The Market Forces of Supply and Demand

●Supply and demand are the forces that make market economies work.●A market is a group of buyers and sellers of a particular good or service.●The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.

The Market Forces of Supply and Demand

Buyers determine demand.

Sellers determine

supply

What Is Demand?● Demand is the willingness and ability

of buyers to purchase different quantities of a good, at different prices, during a specific time period.

Both willingness and ability must be present; if either is missing, there is no demand.

● Quantity demanded is different from demand. Quantity demanded is the AMOUNT of a good that buyers are willing and able to purchase.

Quantity demanded is always a number.

The Law of Demand

● What happens to the quantity demanded when the price changes

● When the price goes up, the quantity demanded goes down—and when the price goes down, the quantity demanded goes up

● They move in opposite directions. Also know as an inverse relationship.

The Law of Demand Equation

The Law of Diminishing

Marginal Utility

What happens to your level of satisfaction as you buy more and more units of the same good?

Testing the Law

TRANSPARENCY 4-2: Diminishing Marginal Utility

●Diminishing means decreasing

●Marginal means additional

●Utility means satisfaction

The law of diminishing marginal utility states:

As a person consumes additional units of a good, eventually the utility gained from each additional unit of the good decreases.

The Law of Demand : A Visual● The table of numbers is called a schedule and

the graph is called a curve. ● We use the graph to help simplify the

complicated aspects of demand.

Catherine’s Demand Schedule

Figure 1 Catherine’s Demand Schedule and Demand Curve

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Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price

...

2. ... increases quantity of cones demanded.

Transparency 4-3: Demand in Tables and Graphs p.93

Demand curve

Demand schedule

Individual and Market Demand Curves

We can look at individual or market demand curves; which are different.

● An individual demand curve represents one person’s demand for a good.

● A market demand curve is the SUM of all the individual demand curves for a good.

Individual and Market Curves

Demand Videos

The Economic LowdownACDC Guy

The Demand Curve Shifts

Change in Quantity DemandedA direct price change affects the quantity demanded of that good. It does not affect demand.Because of a change in price of the GOOD

BEING GRAPHEDResults in movement along the demand curve.

NOT A SHIFT.Remember: Demand and quantity demanded

are not the same thing.

0D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A tax that raises the price of ice-cream cones results in a

movement along the demand curve.

A

B

8

1.00

$2.00

4

Changes in Quantity Demanded

Change in Demand● Results in a shift in the demand curve,

either to the left or right.● When demand goes up, the demand

curve shifts to the right. When demand goes down, the demand curve shifts to the left.

● Results from a change in a determinant of demand ( a ceteris paribus variable)

Figure 3 Shifts in the Demand Curve

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0

5 Factors Cause Demand Curves to Shift

1. Change in Consumer Income. As a person’s income changes, he or she may buy more or less of a certain good.

● As income increases the demand for a normal good will increase.

● As income increases the demand for an inferior good will decrease.

● If demand does not change even though income does, the good is a neutral good.

$3.002.502.001.501.000.50

21 3 4 5 6 7 8 9 10

12

11

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

Increasein

demand

An increase in income...

D1D2

Consumer IncomeNormal Good

$3.002.502.001.501.000.50

21 3 4 5 6 7 8 9 10

12

11

Price of Ice-Cream Cone

Quantity of Ice-Cream

Cones0

Decreasein

demand

An increase in income...

D1D2

Consumer IncomeInferior Good

2. Change in the Prices of Related Goods. When two goods are substitutes, the

demand for one moves in the same direction as the price of the other.

Example: Price of peanuts goes up, demand for pretzels goes up.

When two goods are complements, the demand for one moves in the opposite direction of the price of the other. Complements are goods used together.

Example: Price of tennis rackets goes up, demand for tennis balls falls.

3. Change in the Number of Buyers: A change in the number of buyers, either an increase or a decrease, can change demand.4. Change in Expectations or Future price: Buyers’ expectations of future prices can cause them to buy now or wait to buy. Both actions affect current demand.5. Change in Preferences: Changes in preferences cause changes in demand.

The only factor that affects quantity demanded is a direct price change of the good. Remember: Demand and quantity demanded are not the same thing.

Table 1 Variables That Influence Buyers

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Elasticity of Demand

What Is Elasticity?● Elasticity measures how a price

change affects the quantity of a particular good that people want to buy.

Elasticity of Demand● Demand for a good can be elastic, inelastic,

or unit-elastic. ● Elastic means that a price change has a

significant impact on the quantity demanded. ● Inelastic means that there is a minor

change in quantity demanded when the price changes. And

● Unit-elastic means that the impact of a price change is neutral—that is, neither major nor minor.

How to Measure Elasticity?

Elasticity of Demand

Your answer will tell you the elasticity of demand for that

product.

4 Factors of Elasticity1.Number of substitutes. When there are few substitutes for a good, the quantity demanded is unlikely to change much if the price rises. Therefore, the demand for the good is likely to be inelastic.

● When there are many substitutes for a good, the opposite is true: the demand tends to be elastic. Why pay more when you can switch to the substitute?

2. Luxuries versus necessities. Demand for necessities tends to be inelastic because people need those goods even if prices rise. Demand for luxuries tends to be elastic because people will often do without those goods if prices rise.

3. Percentage of income spent on the good.

If a good requires a large percentage of a person’s income, demand for it tends to be elastic. Too much of the consumers buying power is tied up

in the purchase to ignore price. Demand for goods that require a small percentage of a

person’s income tends to be inelastic.4. Time. When consumers have little time to respond to a price change, demand is usually inelastic. When they have more time to respond, demand is usually elastic.

Relationship Between Elasticity and Revenue

● Elasticity of demand matters to sellers of goods because it relates to their total revenue ● Price x Quantity Sold= Total Revenue● You can look at how the elasticity of a good affects revenue

when sellers change the price of a good● Elastic demand (think LUXURY) and an increase in price lead

to a decrease in total revenue.● Elastic demand (think LUXURY) and a decrease in price lead

to an increase in total revenue.● Inelastic demand (think NECESSITY) and an increase in

price lead to an increase in total revenue.● Inelastic demand (think NECESSITY) and a decrease in price

lead to a decrease in total revenue.