 In market economy: households (consumers) & firms (businesses) enter into a reciprocal relationship  One way of looking at it may be: HouseholdsConsumersBuyers

 In market economies households (consumers) & firms (businesses) enter into a reciprocal relationship  One way of looking at it may be: FirmsBusinessesSellers

 BUT WE NEED TO REMEMBER THE CIRCULAR FLOW CHART  We know that households can be sellers & firms can be buyers

 The relationship between consumers and suppliers results in an agreement :  On pricing  On quantity available for exchange  Demand – is the desire to own something and the ability to pay for it  Willing AND able to buy it  Purchasing Power can be in form of cash or credit  DO NOT MAX OUT YOUR CREDIT SO THAT SUBSTITUTES ARE THE ONLY OPTION IN YOUR FUTURE

 Law of Demand – consumers buy more of a good when its price decreases and less when its price increases  The price influences your decision because of opportunity cost of your decision.

 We have two behaviors that arise from the law of demand:  Substitution effect – when consumers react to an increase in a good’s price by consuming less of that good and increase consumption of other goods.  Goods that serves the same purpose or a different version of the same thing (brands)  Buy good less frequently  Income effect – the change in consumption resulting from a change in real income  You feel poorer when goods cost more, you feel richer when you can afford more of a good  Creates a limited budget

 Demand schedule – a table that lists the quantity of a good a person will buy at each different price  Businesses use the schedule to consider customer reactions to price shifts  Think of it as a trend of consumer consumption

DEMAND SCHEDULEMARKET DEMAND SCHEDULE

 Market demand schedule – a table that lists the quantity of a good all consumers in a market will buy at each different price  Unlike a regular demand schedule which looks at an individual – market demand schedules look at larger quantities that are demanded  It allows for consumer predictability so that businesses can meet consumer demands

 Demand Graph – is a graphic representation of the demand schedule  Price versus Quantity  Vertical axis – lowest possible number at the bottom & highest at top  Horizontal axis – lowest possible number to the left & highest to the right  Connect the points and you have your demand curve

Demand schedule for CD purchases Price# of CDs Purchased $55 $74 $103 $122 $151 $170

 2 things to notice: 1. Only shows the relationship between the price of a good and the quantity that will be bought  It assumes all other economic factors will remain constant = ceteris paribus (Latin for “all other things held constant”) 2. The demand curve slopes downward to the right

 Other factors contribute to the law of demand:  Factors of production can increase or decrease  Technological efficiency can increase or decrease  Innovation can improve a good or render it obsolete

 As the price increases demand decreases and it causes the demand curve to shift › This is known as decrease in the quantity demanded › This occurs ALONG the demand curve  But we know that pricing is NOT the only factor that determines demand

 We can allow other factors for change  But we no longer move along the demand curve  Instead the entire demand curve shifts  Change in Demand - It means that every price point now causes a different quantity to be consumed

 Income level determines demand for:  Normal Goods – A good that consumers demand more of when their incomes increases  Ex: New car, brand names, etc.  If income rises the shift would be to the right – increase in demand  If income falls the shift would be to the left – decrease in demand

 Income level determines demand for:  Inferior Goods – A good that consumers demand less of when their incomes increase  Ex: Used cars, generic goods, etc.  They are “inferior” because the demand for them decreases as one’s income increases  If income rises then we buy less of these items if at all

 Consumer Expectations  More apt to buy if we know the price will increase in the future  If we know that the price will remain constant we can hold off purchasing (sale)  If we know the price will drop in a week then the CURRENT demand for the good will drop to zero

 Population  Size of population will impact the demand curve  As a population increases the demand for certain goods increases  Ex: Baby Boom in 1940s-demand for baby products  1950s-built schools  1960s-more universities  Now-Retirement and senior services

 Demographics: Statistical characteristics of a population  Age, race, gender, occupation, income level  Ex: Increasing Latino population in US  Businesses use to identify potential customers  Have strong influence on packaging, pricing and ads  Consumer Tastes & Advertising  Fads and trends  Advertising plays a HUGE role in the changes of people’s tastes and preferences  Companies use advertising to try increase demand  Social Media: 1.9 million spent on Facebook ads in 2008

 Nike: Just Do It (1988)   Dove: Real Beauty (2004)   Old Spice: The Man Your Man Could Smell Like (2010)   Wendy’s: Where’s the Beef? (1984)   International: Panda Cheese “Never Say No to Panda” 

 Prices of Related Goods  Demand of one good can impact the demand for another  Two types of related goods:  Complements – two goods that are bought and used together  Ex: Skis and Ski Boots  Substitutes – goods used in place of one another

COMPLEMENTS SUBSTITUTES  Coffee – Creamer  Tea – Sugar  Charcoal – Lighter fluid  Hotdogs – hotdog buns  Skis – Snowboards  Perfume – Body Spray  Filets – Hamburgers  House - Condominium

 Elasticity or elasticity of demand - is the way consumers respond to price changes.  It reflects consumer spending habits  Will they cut back or continue to buy a given product regardless of how high the price goes?

Price Range  Elasticity of demand varies at EVERY price point  A good can be elastic at one point and inelastic at another  It really depends on how much out-of-pocket money a person has to spend versus the percentage of increase in price

 Elastic – is demand that is sensitive to price changes  It is elastic if the demand is greater than 1  Inelastic – is demand that is NOT sensitive to price changes  It is inelastic if the demand is less than 1  Unitary Elastic – describes demand whose elasticity is exactly equal to 1  Equal to the percentage change in the price

Availability of Substitutes  Few substitutes or lack of quality alternatives – tendency will be to still buy – INELASTIC  Necessities, regardless of price increase, often maintain their demand – INELASTIC  Luxury goods or wants– ELASTIC  Quality alternative available - ELASTIC

 People change their spending habits over time  Need to find substitutes  Need to reevaluate household budget  Consumer behavior on demand shift  Quick response – ELASTIC  Slow response – INELASTIC  Demand can become more elastic overtime as the consumer resorts to an increase in substitutes  Ex: Gas prices

 Elasticity lets firms know how consumers respond to their price increase.  Consumer response contributes to a firm’s total revenue.  Total revenue – the total amount of money a firm receives by selling goods and services

 How the two work together in terms of demand:  Ex: Lower price of socks by 50% but only sell 20% more-not worth lowering the price  Most of the time: Raising prices raises total revenue  Ex: Pizza Schedule

 Consumers not too responsive to price change  As the price increases the percentage of demand will fall BUT not to the higher percentage elasticity experienced  Overall, firms use the knowledge of a good/service in terms of its elasticity/inelasticity to answer the key economic questions