Unit 4Unit 4

DemandDemandWhere do “prices” come from?Where do “prices” come from?

How are How are prices prices

determined determined in economic in economic

systems?systems?

““Demand is the combination of Demand is the combination of the the willingnesswillingness (have motivation)(have motivation) and and abilityability (have money)(have money) among among consumers to purchase at a consumers to purchase at a particular price.”particular price.”

““DemandDemand” defined:” defined:

Basic Terms in Economics:Basic Terms in Economics: DemandDemand

The Law of DemandThe Law of DemandLaw of DemandLaw of Demand:: There is an There is an inverse inverse (opposite)

relationship between the price of a good and the relationship between the price of a good and the quantity consumers are willing to purchase.quantity consumers are willing to purchase.

What helps explain this relationship???What helps explain this relationship??? The availability of The availability of substitutessubstitutes - goods - goods

that do similar functions -that do similar functions - explains this explains this negative relationshipnegative relationship $

Q

What does the graph show? Inverse relationship!

As consumption increases, additional As consumption increases, additional benefit decreases.benefit decreases.– When When benefitsbenefits >> costscosts: consumption continues : consumption continues

– When When benefitsbenefits << costscosts: consumption ends: consumption ends

Simply put, too much of Simply put, too much of something is a bad thing. This something is a bad thing. This

law also happens explain why the law also happens explain why the curve slopes downward.curve slopes downward.The The firstfirst bottle of water satisfied your bottle of water satisfied your thirst. thirst.

The The secondsecond bottle made you feel totally bottle made you feel totally full. full.

The The thirdthird bottle made you sick. bottle made you sick.

What else does the graph showWhat else does the graph show?? Law of Diminishing Utility Law of Diminishing Utility

EXAMPLE:EXAMPLE:

UtilityUtility(happiness)(happiness)

Quantity Quantity ConsumedConsumed

The Law of Diminishing The Law of Diminishing UtilityUtility

A A market demand schedulemarket demand schedule is a is a tabletable that that shows the quantity of a good people will shows the quantity of a good people will demand at different prices.demand at different prices.

CELL PHONE EXAMPLECELL PHONE EXAMPLE

Consider the market for cell phones (Verizon). Consider the market for cell phones (Verizon). A A market demand schedulemarket demand schedule lays out the lays out the

amount of cell phones that are demanded in the amount of cell phones that are demanded in the market for a spectrum of prices.market for a spectrum of prices.

We can graph these points We can graph these points (price and the (price and the demand for them)demand for them) to make a to make a demand curvedemand curve for for cell phonescell phones..

Where do we get the data for our Demand CurveWhere do we get the data for our Demand Curve??From a “From a “Market Demand Schedule”Market Demand Schedule”

Market Demand ScheduleMarket Demand Schedule

Cell Phone Cell Phone PricePrice

(monthly bill)(monthly bill)

Millions of Millions of Cell Phone Cell Phone SubscribersSubscribers

$129$129 2.1 2.1 $109$109 3.5 3.5 $ 89$ 89 5.1 5.1 $ 69$ 69 7.6 7.6 $ 59$ 59 11.0 11.0 $ 49$ 49 16.0 16.0$ 39$ 39 24.1 24.1

PricePrice(monthly bill)(monthly bill)

QuantityQuantity(of Cell Phone (of Cell Phone Subscribers)Subscribers)

140140

120120

100100

8080

6060

55 1010 1515 2020 2525 3030

Assume this is for a unlimited minute & data package.

Notice that the

Notice that the demand/price relationship

demand/price relationship

is more responsive at

is more responsive at certain price points.

certain price points.

PricePrice(monthly bill)(monthly bill)

QuantityQuantity(of Cell Phone (of Cell Phone Subscribers)Subscribers)

140140

120120

100100

8080

6060

55 1010 1515 2020 2525 3030

•Notice how the law of law of demand demand is reflected by the shape of the demand curve.

• As the price of a good rises …

. . . consumers buy less.

Demand CurveDemand Curve

Market Demand ScheduleMarket Demand Schedule

The slope of the The slope of the demand curve at any demand curve at any quantity shows the quantity shows the maximum price that maximum price that consumers are consumers are WILLINGWILLING and and ABLEABLE to pay for that to pay for that additional unit.additional unit.

Q: What happensQ: What happens

as prices as prices ↑ ↑ & Q & Q ↓↓??

A: utility diminishesA: utility diminishes

Demand Curve & UtilityDemand Curve & Utility

Law of Diminishing UtilityLaw of Diminishing Utility

PricePrice(monthly bill)(monthly bill)

QuantityQuantity(of Cell Phone (of Cell Phone Subscribers)Subscribers)

140140

120120

100100

8080

6060

55 1010 1515 2020 2525 3030

Demand Review

• What is quantity demanded?

• What does the law of diminishing utility state?

• What is the law of demand?

ELASTIC ELASTIC AND AND

INELASTIC DEMANDINELASTIC DEMAND

The Demand & Price The Demand & Price relationship is not the relationship is not the

same for every product.same for every product.LAW OF DEMAND:LAW OF DEMAND:

INVERSEINVERSE RELATIONSHIP BETWEEN RELATIONSHIP BETWEEN PRICEPRICE AND AND QUANTITYQUANTITY..

……but sometimes the relationship between but sometimes the relationship between PRICEPRICE and a and a

change in change in DEMANDDEMAND is not as is not as strongstrong for some goods. for some goods.

: PRICE: PRICE

STRONGER LAW RELATIONSHIPSTRONGER LAW RELATIONSHIP

: PRICE: PRICE

WEAKER LAW RELATIONSHIPWEAKER LAW RELATIONSHIP

MORE SUBSITITUTESMORE SUBSITITUTESLESS SUBSITITUTESLESS SUBSITITUTES

Elasticity of DemandElasticity of Demand

ElasticityElasticity is a measure of is a measure of responsiveness between responsiveness between change in demand and a change in demand and a

change in the pricechange in the price. . It tells how much demand It tells how much demand changes when you change changes when you change the price. the price.

2 Types of Elasticity:2 Types of Elasticity: Inelastic Inelastic ElasticElastic

Elastic DemandElastic Demand

Elastic Demand:Elastic Demand: quantity demanded quantity demanded is is sensitivesensitive to small price changes. to small price changes.

Easy to substitute a good that has elastic Easy to substitute a good that has elastic demand. demand. HAS MANY SUBSTITUTESHAS MANY SUBSTITUTES

When price increases, demand decreases When price increases, demand decreases (business revenue decreases)(business revenue decreases)

Example:Example: price of a good with many price of a good with many substitutes, such as bottle water or soda.substitutes, such as bottle water or soda.

Inelastic Demand

Inelastic Demand:Inelastic Demand: quantity demanded quantity demanded is is NOTNOT sensitivesensitive to price changes. to price changes.Hard to find substitutes for the good. Hard to find substitutes for the good. HAS FEW HAS FEW

OR NO SUBSTITUTESOR NO SUBSTITUTESWhen price increases, business revenue When price increases, business revenue

increasesincreasesExample:Example: needed medication for an illness, needed medication for an illness,

such as Chemo-Therapy & gas.such as Chemo-Therapy & gas.

Elastic and Inelastic Demand CurvesElastic and Inelastic Demand Curves

5.00

1.00

5.00

1.00

Gasoline

Tacos

1 2 3 4 5 6 7 8 9 10

1 2 3 4 5 6 7 8 9 10

If the market price for gasoline was to rise from $1.00 to $5.00, the quantity demanded in the market decreases insignificantly (from 8 to 7 units).(from 8 to 7 units).

If the market price for gasoline was to rise from $1.00 to $5.00, the quantity demanded in the market decreases insignificantly (from 8 to 7 units).(from 8 to 7 units). If the market price for tacos rises from $1.00 to $5.00, the quantity demanded in the market decreases significantly (from 8 to 1 unit).(from 8 to 1 unit).

If the market price for tacos rises from $1.00 to $5.00, the quantity demanded in the market decreases significantly (from 8 to 1 unit).(from 8 to 1 unit). Taco demand is highly sensitivesensitive to price changes and can be described as elasticelastic; gasoline demand is relatively insensitive to price changes and can be described as inelastic.

Taco demand is highly sensitivesensitive to price changes and can be described as elasticelastic; gasoline demand is relatively insensitive to price changes and can be described as inelastic.

ELASTICELASTIC

INELASTICINELASTIC

Elasticity Over Time

Short-RunShort-Run - Consumers - Consumers don’t have don’t have enough time enough time to adjust to the price change to adjust to the price change in a short period of time in a short period of time (ex: stuck with the current (ex: stuck with the current product with no substitutes).product with no substitutes).

Demand tends to be Demand tends to be inelasticinelastic in the in the short-runshort-run

Long-RunLong-Run - Consumers - Consumers have enough timehave enough time to adjust in a longer period of time to adjust in a longer period of time (ex: we will find a substitute to gas if the price remains high)(ex: we will find a substitute to gas if the price remains high)..

Demand tends to be much more Demand tends to be much more elasticelastic in the in the long-runlong-run

Review

• What does elasticity measure?• What is elastic demand?• What is inelastic demand?• What is demand in short run?• What is demand in long run?

““Changes in Quantity Changes in Quantity Demanded”Demanded”

““Changes in DemandChanges in Demand””

VersusVersus

What will cause the demand curve to shift?

What will cause the demand curve to shift?

Changes in the Demand CurveChanges in the Demand Curveversus Quantity Demandedversus Quantity Demanded

Change in Demand CurveChange in Demand Curve - shift - shift OFOF the the entire demand curve.entire demand curve.

Change in Quantity DemandedChange in Quantity Demanded - - movement movement ONON the same demand curve due the same demand curve due to a to a PRICEPRICE change. change.

11 55

$ Price$ Price

QuantityQuantity1010

1.001.00

5.005.00

8.008.00

A shift to the left = A shift to the left = decreasedecrease in in

demanddemand

A shift to the right A shift to the right = = increaseincrease in in

demanddemand

11 55

$ Price$ Price

QuantityQuantity1010

1.001.00

5.005.00

THE DETERMINANTS OF DEMANDTHE DETERMINANTS OF DEMAND

THE THE ONLYONLY FACTORS THAT CAN FACTORS THAT CAN CAUSE A DEMAND CURVE TO CAUSE A DEMAND CURVE TO

SHIFT TO THE SHIFT TO THE LEFTLEFT ( (decreasedecrease) OR ) OR RIGHTRIGHT ((increaseincrease).).

1 5

$ Price$ Price

Quantity10

1.001.00

5.005.00

8.008.00

What specific things determine the What specific things determine the position of the demand curve?position of the demand curve?

““P.O.I.N.T.”P.O.I.N.T.”

Position of the Demand CurvePosition of the Demand Curve??

1.1. PPrice of Related Products rice of Related Products

2.2. OOutlook utlook (Consumer Expectations)(Consumer Expectations)

3.3. IIncomencome

4.4. NNumber of consumersumber of consumers

5.5. TTastesastes

Substitute Goods:Substitute Goods:– As price of one rises the demand for the

other rises

– As price of one falls demand for the other falls

1. PRICE OF RELATED GOODS1. PRICE OF RELATED GOODS

Example:Example: Dr. Thunder Dr. Thunder and Dr. and Dr. Pepper.Pepper.

(assuming they taste the (assuming they taste the same)same)

=$ D

THE DETERMINANTS OF DEMAND THE DETERMINANTS OF DEMAND

““POINT”POINT”

““POINT”POINT”Complementary Goods:Complementary Goods: (they go well together)(they go well together)

– As the price of one rises the demand for the As the price of one rises the demand for the other fallsother falls

– As the price of one falls the demand for the As the price of one falls the demand for the other rises.other rises.

Example:Example: Gas, SUVs, and tires.Gas, SUVs, and tires.

+ =$$

Which way will the Demand curve for Tires shift? A: Shift to the left

DEMANDDEMAND

1. PRICE OF RELATED GOODS1. PRICE OF RELATED GOODS

THE DETERMINANTS OF DEMAND THE DETERMINANTS OF DEMAND

3. INCOME3. INCOME

1. PRICE OF RELATED GOODS1. PRICE OF RELATED GOODS

2. OUTLOOK OF THE FUTURE2. OUTLOOK OF THE FUTURESubstitutesSubstitutes vs vs ComplementsComplements

This could work in This could work in numerousnumerous ways. For ways. For example:example:You hear there is going to be a recession so you You hear there is going to be a recession so you stop spending today –OR– you hear that a sale on stop spending today –OR– you hear that a sale on some clothing is ending soon so you run to make a some clothing is ending soon so you run to make a purchase today.purchase today.

““POINT”POINT”

INCOME INCOME effects SuperiorSuperior and InferiorInferior Goods in

different ways.

THE DETERMINANTS OF DEMAND THE DETERMINANTS OF DEMAND

Superior Goods:Superior Goods: – As income As income risesrises, demand will , demand will increaseincrease (shift right)(shift right)– As income As income fallsfalls, demand will , demand will decreasedecrease (shift left)(shift left)

–Example:Example: Expensive versus cheap cars Expensive versus cheap cars

Vs.Vs.

Income Effects onIncome Effects onSuperior and Inferior GoodsSuperior and Inferior Goods

Inferior Goods:Inferior Goods:– As income risesrises demand fallsfalls – As income fallsfalls demand risesrises

Example: Compact cars, MP3 Players, etc.

Income Effects onIncome Effects onSuperior and Inferior GoodsSuperior and Inferior Goods

5. TASTES 5. TASTES (Affected by attitudes, quality, advertising, etc.)(Affected by attitudes, quality, advertising, etc.)

4. NUMBER OF BUYERS4. NUMBER OF BUYERS

3. INCOME3. INCOME

1. PRICE OF RELATED GOODS1. PRICE OF RELATED GOODS

2. OUTLOOK OF THE FUTURE2. OUTLOOK OF THE FUTURESubstitutesSubstitutes vs vs ComplementsComplements

Superior Superior vs vs InferiorInferior Goods Goods

This could work in This could work in numerousnumerous ways. For ways. For example:example:You hear there is going to be a recession so you You hear there is going to be a recession so you stop spending today –OR– you hear that a sale on stop spending today –OR– you hear that a sale on some clothing is ending soon so you run to make a some clothing is ending soon so you run to make a purchase today.purchase today.

THE DETERMINANTS OF DEMAND THE DETERMINANTS OF DEMAND

““POINT”POINT”

JOHN STOSSEL VIDEOJOHN STOSSEL VIDEO

Link to VideoLink to Video

DETERMINANTS OF DEMANDDETERMINANTS OF DEMAND

Customer are getting even with help Customer are getting even with help from the Internet.from the Internet.

Focus on..Focus on..1.1.How are customers getting back?How are customers getting back?2.2.How has the Internet affected Elasticity of How has the Internet affected Elasticity of Demand?Demand?3.3.How has the Internet affected any (or all) of How has the Internet affected any (or all) of the Determinates of Demand?the Determinates of Demand?

CHAPTER 4 DEMANDCHAPTER 4 DEMAND

STUDY FOR STUDY FOR THE TESTTHE TEST

THE ENDTHE END