Module 5 Demand

What You Will Learn 1 What a competitive market is and how it is described by the supply and demand model What the demand curve is The difference between movements along the demand curve and changes in demand The factors that shift the demand curve 2 3 4

Supply and Demand: A Model of a Competitive Market Five key elements: Demand curve Supply curve Demand and supply curve shifts Market equilibrium Changes in the market equilibrium

The Demand Schedule and the Demand Curve A demand schedule shows how much of a good or service consumers will want to buy at various prices. 7.1 7.5 8.1 8.9 10.0 11.5 14.2 Price of cotton (per pound) Quantity of cotton demanded (billions of pounds) 1.75 1.50 1.25 1.00 0.75 0.50 $2.00 Demand Schedule for Cotton Notes to the instructor: Asking the students about their willingness to pay and how it changes with price always catches their attention. For example, you can talk about iPhones, iPods, movie tickets, or any other goods or services that you think will relate to your students. Different students will have different willingness to pay for the example you choose, and it will also change with price. Class exercise: You can ask your students to select a good or service that they frequently purchase and come up with their own demand schedule indicating their willingness to pay at different prices. This could be a 5-minute in-class exercise. After 5 minutes, you can randomly select students and ask them about their demand schedule. Ask what happens to their quantity demanded as price increases.

The Demand Schedule and the Demand Curve Price of cotton (per pound) A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price. $2.00 Demand curve, D 1.75 1.50 1.25 Figure Caption: Figure 5-1: The Demand Schedule and the Demand Curve The demand schedule for cotton yields the corresponding demand curve, which shows how much of a good or service consumers want to buy at any given price. The demand curve and the demand schedule reflect the law of demand: As price rises, the quantity demanded falls. Similarly, a decrease in price raises the quantity demanded. As a result, the demand curve is downward-sloping. Notes to the Instructor: It could be a good idea to remind students the definition of slope. They should understand that the basic demand curve for a normal good is downward-sloping and also the intuition of its slope. I usually underline the inverse relationship between price and quantity demanded: as one goes up, the other goes down. More will be revealed further in the chapter. Alternatively, you could delay the explanation about the slope until later and then go more into the details of the downward slope, its intuition, exceptions, and so on. 1.00 As price rises, the quantity demanded falls 0.75 0.50 7 9 11 13 15 17 Quantity of cotton (billions of pounds)

Shifts of the Demand Curve An increase in the population and other factors generates an increase in demand—a rise in the quantity demanded at any given price. 7.1 7.5 8.1 8.9 10.0 11.5 14.2 8.5 9.0 9.7 10.7 12.0 13.8 17.0 in 2007 in 2010 $2.00 1.75 1.50 1.25 1.00 0.75 0.50 Price of cotton (per pound) Quantity of cotton demanded (billions of pounds) Demand Schedules for Cotton

Shifts of the Demand Curve This is represented by the two demand schedules: One showing demand in 2007, before the rise in population. The other showing demand in 2010, after the rise in population. 7.1 7.5 8.1 8.9 10.0 11.5 14.2 8.5 9.0 9.7 10.7 12.0 13.8 17.0 in 2007 in 2010 $2.00 1.75 1.50 1.25 1.00 0.75 0.50 Price of cotton (per pound) Quantity cotton demanded (billions of pounds) Demand Schedules for Cotton

Shifts of the Demand Curve Price of cotton (per pound) $2.00 Demand curve in 2010 1.75 1.50 1.25 1.00 Demand curve in 2007 0.75 0.50 D1 D2 Figure Caption: Figure 5-2: An increase in demand An increase in the population and other factors generate an increase in demand—a rise in the quantity demanded at any given price. This is represented by the two demand schedules—one showing demand in 2007, before the rise in population, the other showing demand in 2010, after the rise in population—and their corresponding demand curves. The increase in demand shifts the demand curve to the right. 7 9 11 13 15 17 Quantity of cotton (billions of pounds) A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position—a new demand curve.

Movement Along the Demand Curve A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price. Price of cotton (per pound) A shift of the demand curve… $2.00 1.75 … is not the same thing as a movement along the demand curve. A C 1.50 1.25 B 1.00 Figure Caption: Figure 5-3: Movement Along the Demand Curve Versus Shift of the Demand Curve The rise in quantity demanded from point A to point B reflects a movement along the demand curve: it is the result of a fall in the price of the good. The rise in quantity demanded from point A to point C reflects a shift of the demand curve: it is the result of a rise in the quantity demanded at any given price. Notes to the Instructor: It is very important that the students can distinguish between a shift of a curve and a movement along a curve. I also give the students this general rule: any change in the value of the variables on the vertical and horizontal axis causes a movement along the curve. To generate a shift, we need an outside shock (change in the value of outside—exogenous—variables, which we were assuming to be constant (ceteris paribus), such as population, tastes, and so on. This is also a good opportunity to underline the difference between demand and quantity demanded. In ordinary speech most people, including professional economists, use the word demand casually. For example, an economist might say “the demand for air travel has doubled over the past 15 years, partly because of falling air fares” when he or she really means that the quantity demanded has doubled. It’s OK to be a bit sloppy in ordinary conversation. But when you’re doing economic analysis, it’s important to make the distinction between changes in the quantity demanded, which involve movements along a demand curve, and shifts of the demand curve. Class exercise questions: You can ask your students the following exercise questions: - The price of a can of Coke has increased from $1 to $3. Does this cause a movement along or a shift of the demand curve for Coke? Why? - A new scientific research study has proved that a regular Coke drinker lives on the average 5 years longer than those who do not drink Coke. Does this finding cause a movement along or a shift of the demand curve for Coke? Why? You can ask them to write their answers on a piece of paper, supported by graphical explanations. At the end, you can ask students to correct each other’s answers. Ten minutes would be enough time for this exercise. 0.75 0.50 D1 D2 7 8.1 9.7 10 13 15 17 Quantity of cotton (billions of pounds)

Shifts of the Demand Curve An increase in demand means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1D2) A “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3) Price Quantity D3 D1 D2 Increase in demand Decrease in demand Figure Caption: Figure 5-4: Shifts of the Demand Curve Any event that increases demand shifts the demand curve to the right, reflecting a rise in the quantity demanded at any given price. Any event that decreases demand shifts the demand curve to the left, reflecting a fall in the quantity demanded at any given price.

Understanding Shifts of the Demand Curve Changes in the prices of related goods Substitutes: Two goods are substitutes if a fall in the price of one good makes consumers less willing to buy the other good. Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good. Notes to the Instructor: Substitutes: Ex.: muffins and doughnuts, cereal, and oatmeal. Complements: Ex: squash balls and squash racquets, iPod and earphones. Class exercise questions: - What would be the effect of a sharp increase in the price of squash balls on the demand for squash racquets? Why? - What would be the effect of a sharp increase in the price of Pepsi on the demand for Coke? Why? An interesting example from current events is the debate on building casinos in Massachusetts. Opponents argue that building casinos in Massachusetts would cause a decline in state lottery revenues. This constitutes an example of substitutes (although the expected revenue decrease is only about 6%).

Understanding Shifts of the Demand Curve Changes in income Normal goods: When a rise in income increases the demand for a good—the normal case—we say that the good is a normal good. Inferior goods: When a rise in income decreases the demand for a good, it is an inferior good. Notes to the Instructor: Class exercise questions: -As Talya’s income goes up, she buys less instant noodles. What kind of a good is instant noodles for Talya? - Following David Beckham and Sting, more men start to follow the fashion of wearing skirts. What would the effect of this change in tastes be on the demand for skirts? -Scientists announce that there will be no fish left in the oceans in 5 years. What would be the effect of this announcement on demand for sushi?

Understanding Shifts of the Demand Curve Changes in tastes Changes in expectations

Individual Demand Curve and the Market Demand Curve The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market. Figure 5.5: Individual Demand Curves and the Market Demand Curve Darla and Dino are the only two consumers of jeans in the market. Panel (a) shows Darla’s individual demand curve: the number of pairs of jeans she will buy per year at any given price. Panel (b) shows Dino’s individual demand curve. Given that Darla and Dino are the only two consumers, the market demand curve, which shows the quantity of jeans demanded by all consumers at any given price, is shown in panel (c). The market demand curve is the horizontal sum of the individual demand curves of all consumers. In this case, at any given price, the quantity demanded by the market is the sum of the quantities demanded by Darla and Dino.

Economics in Action Beating the Traffic All big cities have traffic problems. Cities can develop strategies to reduce the demand for auto trips. London imposed a congestion charge on all cars entering the city— currently £10 (about $15). Three years later traffic in central London was about 10 percent lower than before the charge.

Summary The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward. A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price.

Summary A change in the prices of related goods or services Five main factors shift the demand curve: A change in the prices of related goods or services A change in income A change in tastes A change in expectations A change in the number of consumers The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market.