Chapter 4: Demand Section 1 Understanding Demand

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Chapter 4 DemandSection 1Understanding Demand
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Section 1 Objectives

1. Explain the law of demand.
2. Describe how the substitution effect and the
   income effect influence decisions.
3. Create a demand schedule for an individual and a
   market.
4. Interpret a demand graph using demand schedules.

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Imagine for a second

• Your daily routine involves going to Stuft Pizza
  and purchasing two slices of pizza for a dollar
  each.
• Today you go to Stuft, and HALLELUJAH!!! The
  price of pizza has gone down to 50 cents!!!! How
  many pieces would you buy now?
• Tomorrow, Stuft realizes that they lost their
  shirts so they need to raise the price to 2 a
  slice, how many pieces would you buy?

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Understanding Demand

• Demand the desire to own something and the
  ability to pay for it
• Law of Demand consumers will buy more of a good
  when its price is lower and less when its price
  is higher

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• How does the law of demand affect the quantity
  demanded?
• Price changes always affect the quantity demanded
  because people buy less of a good when the price
  goes up.
• By analyzing demand schedules and demand curves,
  you can see how consumers react to changes in
  price.

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Demand

• The law of demand is the result of the
  substitution effect and the income effect --two
  ways that a consumer can change his or her
  spending patterns. Together, they explain why an
  increase in price decreases the amount consumers
  purchase.

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Law of Demand is a product of several patterns of
behavior

• substitution effect when consumers react to an
  increase in a goods price by consuming less of
  that good and more of a substitute good
• income effect the change in consumption that
  results when a price increase causes real income
  to decline

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The Substitution Effect

• The substitution effect takes place when a
  consumer reacts to a rise in the price of one
  good by consuming less of that good and more of a
  substitute good. The substitution effect can also
  apply to a drop in prices.

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The Income Effect

• The income effect is the change in consumption
  that results when a price increase causes real
  income to decline.
• Economists measure consumption in the amount of a
  good that is bought, not the amount of money
  spent on it.
• The income effect also operates when the price is
  lowered. If the price of something drops, you
  feel wealthier. If you buy more of a good as a
  result of a lower price, thats the income effect
  at work.

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The Demand Schedule

• Demand Schedule a table that lists the quantity
  of a good a person will buy at various prices in
  a market
• In order to have demand you must be willing and
  able to buy a good at the specified price

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Market Demand Schedule

• Market Demand Schedule a table that lists the
  quantity of a good all consumers in a market will
  buy at various prices
• Market demand schedules are used to predict the
  total sales of a commodity at several different
  prices.
• Market demand schedules exhibit the law of
  demand at higher prices the quantity demanded is
  lower.

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The Demand Curve

• Demand Curve a graphic representation of a
  demand schedule
• The vertical axis is always labeled with the
  lowers possible prices at the bottom and the
  highest prices at the top.
• The horizontal axis should be labeled with the
  lowest possible quantity demanded at the left and
  the highest possible quantity demanded on the
  right.

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Demand Curves
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Demand Curves

• All demand schedules and demand curves reflect
  the law of demand.
• Market demand curves are only accurate for one
  very specific set of market conditions. They
  cannot predict changing market conditions
• Demand curve can only give info on how buying
  habits will change based on price changes of a
  good.

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Another Example
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• Example Helens demand for lattes.
• Notice that Helens preferences obey the Law of
  Demand.

Price of lattes Quantity of lattes demanded
0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
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Helens Demand Schedule Curve
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Price of lattes Quantity of lattes demanded
0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
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Market Demand versus Individual Demand
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• The quantity demanded in the market is the sum of
  the quantities demanded by all buyers at each
  price.
• Suppose Helen and Ken are the only two buyers in
  the Latte market. (Qd quantity demanded)

Market Qd
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The Market Demand Curve for Lattes
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P
P Qd (Market)
0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
Q
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Review

• Now that you have learned how the law of demand
  affect the quantity demanded, go back and answer
  the Chapter Essential Question.
• How do we decide what to buy?

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Chapter 4 DemandSection 2Shifts in the Demand
Curve
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Objectives

1. Explain the difference between a change in
   quantity demanded and a shift in the demand
   curve.
2. Identify the factors that create changes in
   demand and that can cause a shift in the demand
   curve.
3. Give an example of how a change in demand for one
   good can affect demand for a related good.

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When you Assume?

• ceteris paribus a Latin phrase that means all
  things held under constraint
• Pizza example
• Assumed only price would change
• All else held constant
• We must also consider impact of other changes on
  demand

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Changes in Demand

• A demand schedule takes into account only changes
  in price.
• A demand curve is accurate only as long as there
  are no changes other than price that could affect
  the consumers decision.
• When we drop the ceteris paribus rule and allow
  other factors to change
• Shifts in demand curve change in demand

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You gotta me shiftin me!

• Why does the demand curve shift?
• Shifts in the demand curve are caused by more
  than just price increases and decreases. Other
  factors include
• Buyers
• Income
• Tastes
• Expectations
• Related Goods

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Graphing Changes in Demand

• When factors other than price cause demand to
  fall, the demand curve shifts to the left. An
  increase in demand appears as a shift to the
  right.

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Change in Demand Factors

• Income
• A consumers income affects their demand for most
  goods
• normal good a good that consumers demand more of
  when their income increases most goods are
  normal goods.
• What you want
• inferior good a good that consumers demand less
  of when their income increases
• What I can afford

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Consumer Expectations

• Checkpoint How will an anticipated rise in price
  affect consumer demand for a good?
• The current demand for a good is positively
  related to its expected future price.
• If you expect the price to rise, your current
  demand will rise, which means you will buy the
  good sooner.
• If you expect the price to drop your current
  demand will fall, and you will wait for the lower
  price.

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Population

• Changes in the size of the population will also
  affect the demand for most products.
• Population trends can have a particularly strong
  effect on certain goods.
• Baby Boom two cycle effect

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Demand Curve Shifters of Buyers
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Suppose the number of buyers increases. Then,
at each P, Qd will increase (by 5 in this
example).
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Consumer Tastes Advertising

• Demographics the statistical characteristics of
  populations and population segments, especially
  when used to identify consumer markets
• Businesses use this data to classify potential
  customers.
• Demographics also have a strong influence on
  packaging, pricing, and advertising.

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Change in Tastes

• Example The Atkins diet became popular in the
  90s, caused an increase in demand for eggs,
  shifted the egg demand curve to the right.

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Consumer Tastes continued

• Hispanics, or Latinos are now the largest
  minority group in the United States.
• Firms have responded to this shift by providing
  products and services for the growing Hispanic
  population.
• Firms can also cause shifts by their advertising
  creating a demand for a good

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Prices of Related Goods

• The demand curve for one good can also shift in
  response to a change in demand for another good.
• There are two types of related goods that
  interact this way
• Complements are two goods that are bought and
  used together.
• Substitutes are goods that are used in place of
  one another.

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Summary Variables That Influence Buyers
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• Variable A change in this variable

Price causes a movement along the D
curve of buyers shifts the D
curve Income shifts the D curve Price ofrelated
goods shifts the D curve Tastes shifts the D
curve Expectations shifts the D curve
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A C T I V E L E A R N I N G 1 Demand Curve
Draw a demand curve for music downloads. What
happens to it in each of the following
scenarios? Why?

• A. The price of iPods falls
• B. The price of music downloads falls
• C. The price of CDs falls

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A C T I V E L E A R N I N G 1 A. Price of
iPods falls
Music downloads and iPods are complements. A
fall in price of iPods shifts the demand curve
for music downloads to the right.
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A C T I V E L E A R N I N G 1 B. Price of
music downloads falls
Price of music down-loads
The D curve does not shift. Move down along
curve to a point with lower P, higher Q.
P1
D1
Q1
Quantity of music downloads
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A C T I V E L E A R N I N G 1 C. Price of
CDs falls
CDs and music downloads are substitutes. A
fall in price of CDs shifts demand for music
downloads to the left.
Price of music down-loads
Quantity of music downloads
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Review

• Now that you have learned why the demand curve
  shifts, go back and answer the Chapter Essential
  Question.
• How do we decide what to buy?

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Chapter 4 DemandSection 3Elasticity of Demand
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Objectives

1. Explain how to calculate elasticity of demand.
2. Identify factors that effect elasticity.
3. Explain how firms use elasticity and revenue to
   make decisions.

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Questions

• Are there goods that you would always find money
  to buy, even if the price were ti rise
  drastically?
• Are there other goods that you would cut back on,
  or even stop buying altogether, if the price were
  to raise slightly?

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ELASTICITY

• Economists describe the way that consumers
  respond to price changes as elasticity of demand
• elasticity of demand a measure of how consumers
  respond to price changes

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Sensitive to price change

• Elastic describes demand that is very sensitive
  to a change in price
• Ex apple juice, electronics, bottled water

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Not sensitive to price change

• Inelastic describes demand that is not very
  sensitive to price changes
• Ex concert tickets, life saving medicine

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Values of Elasticity

• Inelastic if elasticity of demand is less than 1
• Elastic if elasticity of demand is greater than 1
• If elasticity is equal to 1, then we describe
  demand as unitary elastic
• Now lets look at how we calculate elasticity

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What is the homeowners elasticity of demand for
gasoline? What factor affected elasticity?
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When Calculating Elasticity of Demand

• The law of demand implies that the result will
  always be negative. This is because increases in
  the price of a good will always decrease the
  quantity demanded, and a decrease in the price of
  a good will always increase the quantity
  demanded.
• We will always convert to a positive solution,
  drop the negative sign

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You try now!

• Marios consumption of tacos
• Mario consumes 4 tacos when the price is 1
• Mario consumes 3 tacos when the price is 1.50
• Calculate Marios elasticity of demand for tacos.
• What does this mean?
• Beccas consumption of cupcakes
• When the price of cupcakes rises by 40
• Beccas quantity demanded falls by 60
• What is the elasticity of demand for Becca?
• What does this mean?

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Last one, just for good measure

• Alberto LOVES Teen Beat Magazine
• When the price is 2 he buys 4 magazines (He is a
  serious collector)
• When the price is raised to 3 he consumes 2
  magazines (He loves the magazine, but he does
  have to eat)
• What is the elasticity of demand?
• What does it tell us?

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Factors affecting elasticity

• Elastic Demand comes from one or more of these
  factors
• The availability of substitute goods
• Relative Importance
• Change over time
• Necessities vs. Luxuries

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Factors Affecting Elasticity

• Availability of Substitutes
• If there are a few substitutes for a good, then
  even when its price rises greatly, you might
  still buy it.
• If the lack of substitutes can make demand
  inelastic, a wide choice of substitute goods can
  make demand elastic.

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Other Factors

• Relative Importance
• A second factor in determining a goods
  elasticity of demand is how much of your budget
  you spend on a good.
• How much you need it vs. wanting it
• Necessities v. Luxuries
• Whether a person considers a good to be a
  necessity or a luxury has a great impact on a
  persons elasticity of demand for that good
• Luxuries goods are generally more elastic

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Other Factors, cont.

• Change Over Time
• Consumers do not always react quickly to a price
  increase, because it takes time to find
  substitutes. Because they cannot respond quickly
  to price changes, their demand is inelastic in
  the short term.
• Demand sometimes becomes more elastic over time
  as people eventually find substitutes.
• Example Car purchase as gas prices fluctuate

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Total Revenue

• Elasticity is important to the study of economics
  because elasticity helps us measure how consumers
  respond to price changes for different products.

• The elasticity of demand determines how a change
  in price will affect a firms total revenue or
  income.
• Total Revenue the total amount of money a
  company receives by selling goods or services

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Total Revenue and Elastic Demand

• The law of demand states that an increase in
  price will decrease the quantity demanded.
• When a good has elastic demand, raising the price
  of each unit sold by 20 will decrease the
  quantity sold by a larger percentage. The
  quantity sold will drop enough to reduce the
  firms total revenue.
• The same process can also work in reverse.

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Remember

• Elastic Demand comes from one or more of these
  factors
• Availability of substitute goods
• A limited budget that does not allow price
  changes
• The perception of the good as a luxury item
• If these conditions are present then the demand
  for a good is elastic

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Total Revenue and Inelastic Demand

• If demand is inelastic, consumers demand is not
  very responsive to price changes. If prices
  increase, the quantity demanded will decrease,
  but by less than the percentage of the price
  increase. This will result in higher total
  revenues.

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Elasticity and Revenue

• Elasticity of demand determines the effect of a
  price change on total revenues.

• Why will revenue fall if a firm raises the price
  of a good whose demand is elastic?
• What happens to total revenue when price
  decreases, but demand is inelastic?

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Elasticity and Price Policies

• Checkpoint Why does a firm need to know whether
  demand for its product is elastic or inelastic?
• Knowledge of how the elasticity of demand can
  affect a firms total revenues helps the firm
  make pricing decisions that lead to the greatest
  revenue.
• If a firm knows that the demand for its product
  is elastic at the current price, it knows that an
  increase in price would reduce total revenue.
• If a firm knows that the demand for its product
  is inelastic at its current price, it knows that
  an increase in price will increase total revenue.

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Review

• Now that you have learned what factors affect
  elasticity of demand, go back and answer the
  Chapter Essential Question.
• How do we decide what to buy?

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Practice makes perfect!

• 1) Yesterday, the price of envelopes was 3 a
  box, and Julie was willing to buy 10 boxes.
  Today, the price has gone up to 3.75 a box, and
  Julie is now willing to buy 8 boxes. Is Julie's
  demand for envelopes elastic or inelastic? What
  is Julie's elasticity of demand?
• 2) If Neil's elasticity of demand for hot dogs is
  constantly 0.9, and he buys 4 hot dogs when the
  price is 1.50 per hot dog, how many will he buy
  when the price is 1.00 per hot dog?

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Just a little bit more!

• 3) Which of the following goods are likely to
  have elastic demand, and which are likely to have
  inelastic demand? Home heating oil , Pepsi ,
  Chocolate , Water , Heart medication Oriental
  rugs
• 4) Katherine advertises to sell cookies for 4 a
  dozen. She sells 50 dozen, and decides that she
  can charge more. She raises the price to 6 a
  dozen and sells 40 dozen. What is the elasticity
  of demand? Assuming that the elasticity of demand
  is constant, how many would she sell if the price
  were 10 a box?

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Answers please

• 1) To find Julie's elasticity of demand, we need
  to divide the percent change in quantity by the
  percent change in price. Change in Quantity
  (8 - 10)/(10) -0.20 -20 Change in Price
  (3.75 - 3.00)/(3.00) 0.25 25 Elasticity
  (-20)/(25) -0.8 0.8 Her elasticity of
  demand is the absolute value of -0.8, or 0.8.
  Julie's elasticity of demand is inelastic, since
  it is less than 1.

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• 2) This time, we are using elasticity to find
  quantity, instead of the other way around. We
  will use the same formula, plug in what we know,
  and solve from there. Elasticity And, in the
  case of John, Change in Quantity (X 4)/4
  Therefore Elasticity 0.9 ((X 4)/4)/(
  Change in Price) Change in Price (1.00 -
  1.50)/(1.50) -33 0.9 (X 4)/4)/(-33)
  ((X - 4)/4) 0.3 0.3 (X - 4)/4 X 5.2
  Since Neil probably can't buy fractions of hot
  dogs, it looks like he will buy 5 hot dogs when
  the price drops to 1.00 per hot dog.

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• 3) Elastic demand Pepsi, chocolate, and Oriental
  rugs Inelastic demand Home heating oil, water,
  and heart medication

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• 4) To find the elasticity of demand, we need to
  divide the percent change in quantity by the
  percent change in price. Change in Quantity
  (40 - 50)/(50) -0.20 -20 Change in Price
  (6.00 - 4.00)/(4.00) 0.50 50 Elasticity
  (-20)/(50) -0.4 0.4 The elasticity of
  demand is 0.4 (elastic). To find the quantity
  when the price is 10 a box, we use the same
  formula Elasticity 0.4 ( Change in
  Quantity)/( Change in Price) Change in Price
  (10.00 - 4.00)/(4.00) 1.5 150 Remember
  that before taking the absolute value, elasticity
  was -0.4, so use -0.4 to calculate the changes in
  quantity, or you will end up with a big increase
  in consumption, instead of a decrease! -0.4
  ( Change in Quantity)/(150) (Change in
  Quantity) -60 -0.6 -0.6 (X - 50)/50 X
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