HOLT: Economics Chapter 3 Demand “These documents are being distributed for educational discussion purposes only.  They do not reflect any attempt by the North East Independent School District, its trustees, administrators, or teachers, to promote any particular viewpoints or opinions expressed in the documents over any others, nor do the viewpoints or opinions expressed in the documents necessarily reflect those of the NEISD, its trustees, administrators or teachers.”

Do you create “demand”? Demand is more than just the desire to purchase a product Wanting something is just not good enough Two important things are necessary… You must be both willing and able to buy a good or service You have to want it and have the money to make the purchase

Two slightly different things… In economic terms demand is the amount of a good or service that a consumer is willing and able to buy at various possible prices during a given time period. Another closely related term is quantity demanded which is the amount of a good or service that a consumer is willing and able to buy at each particular price during a given time period.

What makes us demand more or less? In our free enterprise system, price is the main variable that affects demand for a good or service There is an inverse relationship between the price of a good or service and the quantity demanded for a good or service The lower the price the more we demand The higher the price the less we demand

There is really a Law? The inverse relationship has been described as a law. The Law of Demand An increase in a good’s price causes a decrease in the quantity demanded and a decrease in price causes an increase in quantity demanded You probably knew the concept without knowing it was a law!

Purchasing Power The amount of money, or income, that people have available to spend on goods and services is called their purchasing power As our purchasing power increases our demand for goods and services tends to increase too As our purchasing power decreases our demand for goods and services tends to decrease too

Changes Three concepts illustrate the changes that occur as prices for goods and services go up or down The Income Effect The Substitution Effect Diminishing Marginal Utility

Income Effect (Same Money, Lower/Higher Prices) Any increase or decrease in consumers’ purchasing power caused by a change in price is called the income effect As prices go down we feel like we have more money and tend to buy more goods and services with the same money As prices go up we feel like we have less money and tend to buy less goods and services with the same money

The Substitution Effect The tendency of consumers to substitute a similar, lower-priced product for another product that is relatively more expensive is the substitution effect Hamburger instead of steak Margarine instead of butter Hill Country Fare instead of Green Giant Quantity demanded of the higher priced item goes down/quantity demanded of the lower priced item goes up

Marginal Utility In economics always associate the word utility with usefulness or satisfaction In economics always associate the word marginal with the value one As we consume additional units of a product, our satisfaction with that additional product typically rises One more...

Diminishing Marginal Utility Diminishing means that something goes down or decreases Diminishing Marginal Utility is when the extra usefulness (utility) of a product goes down (diminishes) with the consumption of each additional unit (margin). Lemonade Stand This explains why the demand for a product is not limitless

Demand Schedules A easy way to show the relationship between the price of a good or service and the quantity that consumers demand is by showing it on a demand schedule It illustrates that as price goes up, demand goes down

Demand Curves A demand curve illustrates the same thing as a demand schedule, but plots the information on a graph Both the demand curve and the demand schedule shows the price/demand relationship at a specific time. We call that a snapshot in time Since the timeframe is the same, the only thing that changes demand is price

Sec. 2: Changes In Demand Time does not stand still and neither do markets The passage of time allows factors other than price to influence demand. These other factors are called determinants of demand Consumer tastes and preferences Market size Income Prices of related goods Consumer expectations

Non-Price Changes The determinants of demands listed on the previous slide can cause the demand for a good or service to increase or decrease at every price level

Consumer Tastes and Preferences Recording artists come and go VHS movies to DVD movies to Blue Ray movies Tube type TV’s to flat panel TV’s Wired internet to wireless internet Home phones to cell phones Demand for one product falls as demand for another similar product increases

Market Size Market size is influenced by advertising which can increase demand by attracting new customers Foreign markets are developed that brings in new customers Technological advances attract new customers

Income As peoples income increases and they have more money to spend, demand for goods and services increase (raises/new jobs) As peoples income decreases and they have less money to spend, demand for goods and services decrease (layoffs/retirement/hours cut back) This is different from the income effect because that was brought on by a price change, not a real income increase/decrease

Prices of Related Goods Goods that can be used to replace the purchase of similar goods when prices rise are called substitute goods When consumers switch to lower price substitutes we call that the substitute effect Butter/Margarine Steak/hamburger

More about related goods… Goods that are commonly used with other goods are known as complimentary goods Paint/paint brushes Guns/ammunition Hot Dogs/Hot Dog Buns Ink Jet Printers/print cartridges As demand for these goods increase the demand for its complimentary good increases at the same time

Consumer Expectations Sometimes demand increases/decreases based only on an expectation that your income is going to increase/decrease New job after graduation… You think you are getting a raise… Promotion… New company owners… Lay offs… You make changes even though the increase/decrease has not actually happened

Sect. 3: Elasticity of Demand Elasticity of demand is the degree to which changes in a good’s price affect the quantity demanded by consumers Elasticity of demand can be either elastic or inelastic Demand is said to be elastic if an increase/decrease causes a corresponding increase/decrease in sales of the product Manufacturers/Service Providers must consider this before increasing the prices for their goods or services. Will total revenue rise or fall?

Elastic Demand Elastic Demand exists when a small change in a good’s price causes a major, opposite change in quantity demanded Goes both ways….. A small increase in price causes a significant decrease in sales A small decrease in price causes a significant increase in sales Tickets to movies/video rentals

What makes demand for some goods elastic? The product is not a necessity There are readily available substitutes The product’s cost represents a large portion of a consumers income

Inelastic Demand Inelastic demand exists when a change in a good’s price has little impact on quantity demanded A good usually has an inelastic demand if.. The product is a necessity…. There are few or no readily available substitutes for the product… The products cost represents a small portion of a consumers income… Salt, soap, insulin...

Elasticity in Specific & General Markets Are you looking at a big market or a smaller segment of a market Price of gasoline in your neighborhood or out on the interstate…. Lots of grocery stores vs. only one or two

Measuring Elasticity Business can measure elasticity by applying the total revenue test The total revenue test is the total income that a business receives from selling it’s product Measurement must be taken before/after a change in price takes place Does the increase/decrease in price increase/decrease total revenue?

Rising Prices vs. Demand If total revenue decreases following an increase in price of the product/service, demand for that product is generally said to be elastic If total revenue increases following an increase in price of the product/service, demand for that product is generally said to be inelastic Total Revenue = Quantity Sold X Price

Maximizing Total Revenue A provider of goods and services must find the price that brings in the most revenue… Notice that the lowest price is not always the price that maximizes revenue

Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston, References Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston,