Demand and supply – Theory

A nice and reasonably general definition of Demand: Demand relates amounts people want to obtain to the sacrifices they must make.

The textbook definition of Demand DEFINITION 1: Demand is a relationship between two variables: Price and the quantity demanded. Therefore Demand cannot be expressed by a single number; it is not a fixed amount determined by nature. What is quantity demanded? DEFINITION 2: Quantity demanded of a good is the amount of that good that buyer(s) are willing and able to purchase.

What determines the “quantity demanded”? Price of the good itself Consumer Income (normal goods, inferior goods) Prices of related goods [substitutes and complements] Taste Expectations In mathematical terms: QD = f(P, I, P*; T, E) [QD denotes the quantity demanded, it is a function of variables P, I, P*, T,]

The Demand Curve: The Relationship between Price and Quantity Demanded Demand (Schedule/Curve) The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded, with all other variables-income, prices of other goods, etc., kept constant. 17

Zeynep’s Demand Schedule Price of Ice-cream cone Quantity of Ice-cream cones demanded 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00

The Demand Curve: The Relationship between Price and Quantity Demanded Demand Curve is a graph of the relationship between the price of a good and the quantity demanded, with all other things kept constant. 17

Zeynep’s Demand Schedule and Demand Curve Price of Ice-Cream Cone 3.00 2.50 1. A decrease in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of 2. ... increases quantity of cones demanded. Ice-Cream Cones Copyright © 2004 South-Western

The (glorious) Law of Demand The law of demand is the claim that, other things being equal (ceteris paribus in Latin), if the price of the good rises, the quantity demanded falls if the price of the good falls, the quantity demanded rises.

The original version of the Law of Demand (by Alfred Marshall) "There is then one general law of demand: The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchasers; or, in other words, the amount demanded increases with a fall in price, and diminishes with a rise in price.“ Alfred Marshall, (1842-1924) Principles of Economics, 8th edition (London: Macmillan, 1920), 99 [originally published in 1890]

Changes in Quantity Demanded Price of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. B 2.00 A 1.00 D 4 8 Quantity of Ice-Cream Cones

Market Demand versus Individual Demand Market demand is the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

The market demand curve is the horizontal sum of the demand curves of all individuals.

Before we talk about the shifts in the demand curve Recall that a change in Quantity Demanded is (shown) as a Movement along the demand curve, and is Caused by a change in the price of the product. 19

A change in demand vs. a change in quantity demanded When the price of a good changes (for whatever reason) this will cause a change in the quantity demanded of that good, but will not cause a change in the demand for that good.

Change in Demand Change in Quantity Demanded

Change in Quantity Demanded Movement along the demand curve. Caused by a change in the market price of the product.    Change in Demand A shift in the demand curve, either to the left or right. Caused by a change in a determinant other than price.

What makes the Demand Curve shift? Consumer income Prices of related goods Tastes Expectations Number of buyers 11

Shifts in the Demand Curve Change in Demand A shift in the demand curve, either to the left or right. Caused by any change that alters the quantity demanded at every price. 19

Shifts in the Demand Curve Price of Ice-Cream Cones Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of Ice-Cream Cones Copyright©2011 South-Western

Shifts in the Demand Curve Consumer Income As income increases the demand for a normal good will increase. As income increases the demand for an inferior good will decrease.

Shifts in the Demand Curve : Consumer Income As income increases the demand for a normal good will increase. As income decreases the demand for a normal good will decrease. This is also the definition of a normal good: A good for which demand increases (falls) as income increases (declines) is a normal good.

Consumer Income Normal Goods Price of Ice-Cream Cones 3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Shifts in the Demand Curve : Consumer Income As income increases the demand for an inferior good will decrease. As income decreases the demand for an inferior good will increase. This is also the definition of an inferior good: A good for which demand decreases as income increases is an inferior good.

Consumer Income Inferior Goods Price of Ice-Cream Cones 3.00 2.50 An increase in income... 2.00 Decrease in demand 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Shifts in the Demand Curve Prices of Related Goods When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements.

Shifts in the Demand Curve: Prices of Related Goods Complement goods Cars and gasoline Tennis balls and rackets Laptop computers and computer software Simit peynir Köfte ekmek Doktor – sigara Demand for a good will increase when the price of a complement good falls.

D2 D1 Price of related good : Complement goods Price of Ice-Cream Cone $3.00 2.50 An increase in price of a complement good... 2.00 Decrease in demand 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12 Fall 2005, Emanuele Gerratana

Complements : Peanut butter and jelly When the price of peanut butter rises, demand for jelly falls, that means : the demand curve for jelly shifts to the left.

Shifts in the Demand Curve: Prices of Related Goods Substitute goods Pepsi and Coca Cola Butter and margarine Notebook computers and netbook computers Beyaz peynir kaşar peyniri Keşkül muhallebi Demand for a good will increase when the price of a substitute good rises.

D2 D1 Price of a related good : Substitute goods Price of Ice-Cream Cone $3.00 An increase in price of a substitute good... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12 Fall 2005, Emanuele Gerratana

Substitute goods : Tea and Coffee When the price of coffee rises, demand for tea increases, that means : the demand curve for tea shifts to the right.

Variables That Influence Buyers Copyright©2010 South-Western