The Economic Way of Thinking 10e ©Prentice Hall “The Economic Way of Thinking” 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Substitutes Everywhere: The Concept of Demand PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline I.Introduction II.On the Notion Of “Needs” III.The Concept of Demand IV.Marginal Values V.Decisions at the Margin VI.Making it Graphic

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline VII.Demand and Quantity Demanded VIII.The Difference It Makes IX.Law of Demand: A Summary X.Misperceptions caused by Inflation XI.Time is on Our Side XII.Price Elasticity of Demand XIII.Thinking about Elasticity Chapter Outline

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline XIV.Elasticity and Total Receipts XV.The Myth of Vertical Demand XVI. All Scarce Goods Must be Rationed Somehow XVII. Money Cost and Other Cost XVIII. Once Over Lightly Chapter Outline

The Economic Way of Thinking 10e ©Prentice Hall Introduction Most goods are scarce.Most goods are scarce. –Sacrifice is necessary. There are substitutes for everything.There are substitutes for everything. Intelligent choice entails trade-offs.Intelligent choice entails trade-offs. Market price signals encourage buyer to economizeMarket price signals encourage buyer to economize Most goods are scarce.Most goods are scarce. –Sacrifice is necessary. There are substitutes for everything.There are substitutes for everything. Intelligent choice entails trade-offs.Intelligent choice entails trade-offs. Market price signals encourage buyer to economizeMarket price signals encourage buyer to economize

The Economic Way of Thinking 10e ©Prentice Hall What is wrong with the following statements?What is wrong with the following statements? 1) Fire safety requires that there be two exits from each apartment unit. 2) We need a new car. What is wrong with the following statements?What is wrong with the following statements? 1) Fire safety requires that there be two exits from each apartment unit. 2) We need a new car. Introduction

The Economic Way of Thinking 10e ©Prentice Hall On the Notion of “Needs” What is the relationship between “tradeoffs” and “needs”?What is the relationship between “tradeoffs” and “needs”? Consider these four statements………Consider these four statements……… 1.The average person needs eight glasses of water per day to maintain good health. 2.All citizens should be able to obtain the medical care they need regardless of their ability to pay. 3.A diabetic needs insulin. 4.You need to read your economics textbook. All of these statements have necessity in common. All of these statements have necessity in common.

The Economic Way of Thinking 10e ©Prentice Hall Higher prices (sacrifices) lead people to seek substitutes. The fact that goods and services are scarce entails tradeoffs, i.e., the sacrifice of other goods and services that we value. Higher prices (sacrifices) lead people to seek substitutes. The fact that goods and services are scarce entails tradeoffs, i.e., the sacrifice of other goods and services that we value. On the Notion of “Needs”

The Economic Way of Thinking 10e ©Prentice Hall The Concept of Demand Demand Relates amounts people want to obtain to the sacrifices they must make When a want can only be satisfied at some cost we accept less. Demand Relates amounts people want to obtain to the sacrifices they must make When a want can only be satisfied at some cost we accept less.

The Economic Way of Thinking 10e ©Prentice Hall “Law of Demand” A negative relationship exists between the amount of anything that people want to purchase and the price they must pay. The Concept of Demand

The Economic Way of Thinking 10e ©Prentice Hall Question: Are there any exceptions to the Law of Demand? “Let’s stock up before the price goes even higher.” Answer: Alleged exceptions are based on misinterpretation of the evidence. Expectations of future price increases encourages people to buy more now, so that they can buy less later at the higher price. The Concept of Demand

The Economic Way of Thinking 10e ©Prentice Hall Marginal Values Questions Which is more valuable, water or diamonds? Which is more valuable, a glass of water or a glass of diamonds? Answers: The values that matter are marginal values Marginal means “additional”, so in economics we make decisions based on expected marginal benefits, versus marginal cost.

The Economic Way of Thinking 10e ©Prentice Hall Decisions at the Margin Decisions are not made in terms of “all or nothing.”Decisions are not made in terms of “all or nothing.” The “Economic Way of Thinking”….The “Economic Way of Thinking”…. –Measures the change in one alternative, versus the change in another, compared to the original state of affairs. –Marginal decision making is true for people who economize on any scarce food, including a basic “necessity” such as water.

The Economic Way of Thinking 10e ©Prentice Hall Making It Graphic Graphs can be used to illustrate relationships. Demand Curves Illustrate the relationship between price and quantity demanded Graphs can be used to illustrate relationships. Demand Curves Illustrate the relationship between price and quantity demanded

The Economic Way of Thinking 10e ©Prentice Hall Price per Gallon Gallons per Day $ Making It Graphic Demand Schedule is a tabular representation of graphical data:

The Economic Way of Thinking 10e ©Prentice Hall GALLONS OF WATER PER DAY $.07 PRICE PER GALLON.01 Making It Graphic

The Economic Way of Thinking 10e ©Prentice Hall Economic theory assumes: Households compare price with its “utility.” Consumption decreases when marginal benefit is less than the price. Total usefulness is the area under the curve. Making It Graphic

The Economic Way of Thinking 10e ©Prentice Hall Demand and Quantity Demanded “A change in demand” is not the same thing as a “change in quantity demanded”. Demand is a relationship between two specific variables. It is a schedule or a curve. D Q P D1 Q P D2 Change in Quantity demanded: Change in demand::

The Economic Way of Thinking 10e ©Prentice Hall PriceQuantity Demanded 50 cents125, , ,000 Demand and Quantity Demanded

The Economic Way of Thinking 10e ©Prentice Hall A change in quantity demanded is a movement from one point on a curve to another point on the same curve.A change in quantity demanded is a movement from one point on a curve to another point on the same curve. A change in demand results from some other factor that makes households buy more at each price.A change in demand results from some other factor that makes households buy more at each price. –The demand curve shifts. Demand and Quantity Demanded

The Economic Way of Thinking 10e ©Prentice Hall Price per GallonOriginal Gallons/DayNew Gallons/Day $ Demand and Quantity Demanded

The Economic Way of Thinking 10e ©Prentice Hall GALLONS OF WATER PER DAY $.07 PRICE PER GALLON.01 Demand and Quantity Demanded

The Economic Way of Thinking 10e ©Prentice Hall $ Price Per Gallon Demand and Quantity Demanded Original Gallons/ Day New Gallons/ Day

The Economic Way of Thinking 10e ©Prentice Hall GALLONS OF WATER PER DAY $.07 PRICE PER GALLON.01 Demand and Quantity Demanded

The Economic Way of Thinking 10e ©Prentice Hall The Difference It Makes An editorial in The Wall Street Journal incorrectly stated,An editorial in The Wall Street Journal incorrectly stated, –“The coffee market is behaving the way the basic textbooks say a market behaves: Prices go up, demand falls, and prices come down.” Price and quantity demanded move in opposite directions.Price and quantity demanded move in opposite directions.

The Economic Way of Thinking 10e ©Prentice Hall Demand for a good is a function of: Biological realities Social relationships Psychological factors Economic variables IncomeSubstitutes Demand for a good is a function of: Biological realities Social relationships Psychological factors Economic variables IncomeSubstitutes The Difference It Makes

The Economic Way of Thinking 10e ©Prentice Hall P Q D1D1 D2D2 A fall in the demand The Difference It Makes

The Economic Way of Thinking 10e ©Prentice Hall D P Q P1P1 Q1Q1 P2P2 Price goes up, quantity demanded goes down, period! Q2Q2 The Difference It Makes

The Economic Way of Thinking 10e ©Prentice Hall Demand for bicycles: effect of a lower price P Q The Difference It Makes

The Economic Way of Thinking 10e ©Prentice Hall P Q Demand for bicycles: effect of environmental concern The Difference It Makes

The Economic Way of Thinking 10e ©Prentice Hall The Law of Demand A Summary Other things constant, if the price of a good changes, the quantity demanded changes.Other things constant, if the price of a good changes, the quantity demanded changes. A higher price decreases quantity demanded.A higher price decreases quantity demanded. A lower price increases quantity demanded.A lower price increases quantity demanded. A change in price causes movement along a stable demand curve. When something other than price changes, the whole demand curve changes (shifts) either to the right (increase), or to the left (decrease).When something other than price changes, the whole demand curve changes (shifts) either to the right (increase), or to the left (decrease).

The Economic Way of Thinking 10e ©Prentice Hall The Law of Demand A Summary The non-price determinants of demand that encourage consumers to buy more or less are……… Changes in consumer taste and preferences. Changes in incomes. Changes in the price of other goods and services. Changes in expectations. Demand can increase or decrease because of these factors.

The Economic Way of Thinking 10e ©Prentice Hall Time Is On Our Side Changes in the quantity demanded takes time. These changes will be greater for any price change the longer the time period allowed for adjustment. It takes time for customers to find and begin to use substitutes. It also takes time for producers to devise, produce, and publicize substitutes.

The Economic Way of Thinking 10e ©Prentice Hall Price Elasticity of Demand Price elasticity of demand measures consumer responsiveness to price changes. Inelastic Demand If quantity demanded changes very little as a result of a large change in price. Elastic Demand If quantity demanded changes substantially as a result of a small change in price.

The Economic Way of Thinking 10e ©Prentice Hall Price Elasticity of Demand

The Economic Way of Thinking 10e ©Prentice Hall Example Price increases by 20% Quantity demanded decreases by 50% Consumers are relatively responsive ElasticExample Price decreases by 20% Quantity demanded increases by 15% Consumers are relatively unresponsive Inelastic Price Elasticity of Demand

The Economic Way of Thinking 10e ©Prentice Hall Elastic Demand Price elasticity > 1 Inelastic Demand Price elasticity < 1 Unit Elastic Price elasticity = 1 Price Elasticity of Demand

The Economic Way of Thinking 10e ©Prentice Hall Thinking About Elasticity “People aren’t going to buy much more no matter how far we cut the price.” “This is a competitive business. We would lose half our customers if we raised our prices by as little as 2 percent.” Question Would a firm want to lower price if demand were inelastic? Question Would a firm want to raise price if demand were elastic? The answer is no to both questions.

The Economic Way of Thinking 10e ©Prentice Hall D Inelastic Demand P Q Thinking About Elasticity

The Economic Way of Thinking 10e ©Prentice Hall D Elastic Demand P Q Thinking About Elasticity

The Economic Way of Thinking 10e ©Prentice Hall QuestionQuestion –Can food stores charge any price they want since they sell food? QuestionQuestion –Would it be wise to impose a tax on table salt? QuestionQuestion –Would the demand for Morton’s salt be more elastic or inelastic than the demand for salt? Thinking About Elasticity

The Economic Way of Thinking 10e ©Prentice Hall A product’s elasticity depends upon…. The proportion of one’s budget spent on an item. The more a product takes of your budget, the more elastic. The more substitutes a product has, the more elastic. Necessities are less elastic than luxuries. All products become more elastic with time. Thinking About Elasticity

The Economic Way of Thinking 10e ©Prentice Hall Elasticity and Total Receipts “The university’s total receipts from tuition would actually increase if tuition rates were cut by 20 percent.” The 20 percent cut in prices must cause quantity demanded to increase by more than 20 percent. Elastic demand

The Economic Way of Thinking 10e ©Prentice Hall “It’s odd but true. Wheat farmers would gross more money if they all got together and burned one-quarter of this year’s crop.” Elastic Demand Prices and total receipts move in opposite directions. Inelastic Demand Prices and total receipts move in the same direction. Elasticity and Total Receipts

The Economic Way of Thinking 10e ©Prentice Hall P Q D Elastic demand between C and E since OBCG < OAEF. B C G A E F O Elasticity and Total Receipts

The Economic Way of Thinking 10e ©Prentice Hall P Q D A Inelastic demand between A and B. B Elasticity and Total Receipts

The Economic Way of Thinking 10e ©Prentice Hall P Q Demand for wheat The market price when entire crop is sold The price when 1/4 of crop is burned. Elasticity and Total Receipts

The Economic Way of Thinking 10e ©Prentice Hall The Myth of Vertical Demand P Q D P1P1 P2P2

The Economic Way of Thinking 10e ©Prentice Hall  Question  Does a perfectly inelastic demand curve exist?  Will consumers buy the same quantity at all prices?  There is no such thing as a completely inelastic demand curve over the entire possible range of prices.  If the price of insulin falls diabetics would be more likely to purchase a larger quantity, implying that the demand curve for insulin is downward sloping. The Myth of Vertical Demand

The Economic Way of Thinking 10e ©Prentice Hall All Scarce Goods must be Rationed Somehow Market prices and willingness to pay are our primary criteria for rationing goods and services. If a good is scarce, sacrifices must be made to obtain it. When prices of products and services rise, people respond by economizing in their use. People naturally find ways to economize that entail the least sacrifices.

The Economic Way of Thinking 10e ©Prentice Hall Scarce goods must be rationed. Rationing can be done by willingness to pay prices. Other ways to ration: “First come, first served” Lottery Equal shares for all “Might makes right” Merit All Scarce Goods must be Rationed Somehow

The Economic Way of Thinking 10e ©Prentice Hall Money Costs and Other Costs People respond to changes in cost: ExplicitImplicit Money is a common denominator, a yardstick, and a measure of value. Changes in money prices are a useful device for coordinating people’s behavior.

The Economic Way of Thinking 10e ©Prentice Hall Once Over Lightly TradeoffsScarcitySubstitutesMarginalismNeeds The Law of Demand Demand Schedule Changes in Demand Non-Price Determinants of Demand RationingElasticity

End of Chapter 3 Next Chapter 4 Opportunity Cost and the Supply of Goods