Text of The Demand for Goods Chapter-5. In This Chapter. 5.1.Why is demand curve downward slopping? 5.2. How...
The Demand for Goods Chapter-5
In This Chapter. 5.1.Why is demand curve downward slopping? 5.2. How to measure behavioral responses of consumers to changes in determinants of demand (Elasticity)? 5.3. The Effect of Elasticity on the Revenue of the Producer (Seller). 5.3. How Consumers Allocate their Income Among Competing Ends?
5.1.What Explains the Consumer Behavior? What determines what we buy? How we buy? What leads us to buy some goods while rejecting others? Why do we buy more at lower prices and less at higher prices?
5.1.What Explains the Consumer Behavior? Two Explanations The Sociopsychiatric Explanation The Economic Explanation
5.1.What Explains the Consumer Behavior? 1.The Sociopsychiatric Explanation In Freuds view, higher levels of consumption satisfy our basic drives for security, sex, and ego gratification. According to sociologists, consuming more is an expression of identity that provokes recognition or social acceptance.
5.1.What Explains the Consumer Behavior? The Economic Explanation In explaining consumer behavior, economists focus on the demand for goods and services. Demand is the willingness and ability to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus.
The Economic Explanation An individuals demand for a product is determined by: Tastesdesire for this and other goods. Incomeof the consumer. Expectationsfor income, prices, tastes. Other goodstheir availability and prices.
The Economic Explanation Economists use the Demand Curve to Explain the consumer behavior how consumer tastes affect consumption decisions. Law of demand: Ceteris paribus, individuals buy less quantities, when prices are higher and more quantities when prices are lower. They do so because they have a goal of getting maximum Possible Satisfaction (Pleasure) from their limited resources. Utility
The Economic Explanation Utility is the pleasure or satisfaction obtained from a good or service. Utility Theory Measuring Utility (Satisfaction) Cardinal Units (absolute numbers indicating levels): Utils Ordinal Unity (Rankings, Orders of preferences)
The Economic Explanation Total Utility is the amount of satisfaction obtained from entire consumption of a product. The more we consume of a product the more utility (satisfaction) we obtain. I.e., More is Preferred to Less! Thus the more pleasure (utility) a product gives us, the higher the price were willing to pay for it.
The Economic Explanation However, more is not always and necessarily better. Two Distinct Levels of Satisfaction: 1.Total Utility 2.Marginal (additional) Utility
The Economic Explanation Total Utility : the amount of satisfaction obtained from the entire consumption of a product. Marginal utility: the change in total utility obtained by consuming one additional (marginal) unit of a good or service.
The Economic Explanation There is a natural limit to how much more... Total Utility 1023456 Quantity of Popcorn (boxes per show) Total utility Rising total utility TOTAL UTILITY
The Economic Explanation Although we prefer more to less, more is not always and necessary better Human Behavior: When we have more and more of some thing we start to value it less and less. We do so The additional satisfaction we get from consuming one more unit of the same product is lower than the level of satisfaction we obtain from consuming earlier units of the product. Declining Marginal Utility
The Economic Explanation Total Utility 1023456 Quantity of Popcorn (boxes per show) Total utility Rising total utility TOTAL UTILITY Marginal Utility 10234 Quantity of Popcorn (boxes per show) Diminishing marginal utility 56 Negative marginal utility MARGINAL UTILITY
Diminishing Marginal Utility According to the law of diminishing marginal utility, the marginal utility of a good declines as more of it is consumed in a given time period. As long as marginal utility is positive, total utility must be increasing.
Diminishing Marginal Utility According to the law of diminishing utility, each successive unit of a good consumed yields less additional utility. Eventually, additional quantities of a good yield increasingly smaller increments of satisfaction. Downward slopping Demand Curve
The Economic Explanation Implication Our consumption decision is guided by not by how much total satisfaction we get, but by how much additional satisfaction we get when consuming one more unit of a product
The Economic Explanation Demand Curve: Price and Quantity relationship (Why is it downward slopping?) Tastes, through marginal utility, tells us how much we desire particular goods. Price tell us how much of a good we will buy. The more marginal utility a product delivers, the more a consumer is willing to pay, ceteris paribus. As the marginal utility of a good diminishes, so does our willingness to pay.
5.2. Gagging Responses to Changes in the Determinants of Demand
According to the law of demand, the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus. (Own Price, Income, Price of other Products,.)
5.2. Gagging Responses to Changes in the Determinants of Demand Elasticity A measure of the responsiveness (the sensitivity) of consumers (buyers) in terms of the quantities they buy, to changes in the determinants of demand (Own Price, Income of the Consumer, Price of Other Goods, etc)
5.2. Gagging Responses to Changes in the Determinants of Demand Elasticity Price Elasticity of Demand Income Elasticity of Demand Cross Price Elasticity of Demand
Price Elasticity (E) The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Is a measure of the response of consumers to a changes in own price of a product.
Individuals Demand Schedule and Curve Quantity Demanded (Ounces per show) PRICE (per ounce) A B C D E F G H I J 048121620242832 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 $0.55 The willingness to pay diminishes along with marginal utility
Computing Price Elasticity (E)
Computing Price Elasticity To ensure consistency, average quantity and average price (before and after) is used in the calculation of Elasticity.
Computing Price Elasticity
Note on the Sign of Price Elasticity (E) of Demand The price elasticity of demand (E) is always negative because quantity demanded decreases when prices increase. However, as we often use its absolute value, the price elasticity of demand is reported as a positive number (greater than zero).
In Class Hands-on-Problem Quantity Demanded (Ounces per show) PRICE (per ounce) A B C D E F G H I J 048121620242832 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 $0.55 Compute Elasticity for A movement from 1.C to D 2.G to H 3.J to I
Possible Values of Elasticity: |E| E can take any value between from 0 to infinity Five Broad categories 0
5.3. Elasticity and Pricing Decision A price hike increases total revenue of a seller only if demand is inelastic (E < 1). if demand is elastic (E > 1), a hike in price reduces total revenue of the seller. if demand is unitary elastic (E = 1), hike in price does not change total revenue of the seller
5.3. Elasticity and Pricing Decision A decline in price (Sales Discount) on the other hand increases total revenue of a seller if the demand is elastic (E > 1). If the demand is inelastic (E
2461012141618202224262830328 0 $0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 QUANTITY DEMANDED (ounces per show) PRICE (per ounce) B C At higher prices E > 1 At Lower prices E < 1
$8 7 6 5 4 3 2 1 0 PRICE 102030405060708090100110 Elastic E > 1 Unit elastic E = 1 Inelastic E < 1 The demand curve $225 200 175 150 125 100 75 50 25 0 Elastic E > 1 Inelastic E < 1 102030405060708090100110 TOTAL REVENUE Total revenue E = 1
How consumers Decide to Allocate their Income ( Choosing Among Products )
5.4. Choosing Among Products Goal: Utility Maximization Consumers should choose the optimal consumption combination. the mix of consumer purchases that maximizes the utility attainable from available income (budget).
5.4. Choosing Among Products The purchase of any one single good also means giving up the opportunity to buy more of other goods. Recall Opportunity costs The alternatively most desired goods or service