Supply and Demand DEMAND

In order to have demand you need someone with the desire for the product, ability to pay, and willingness to purchase. (BUYER). A change in price creates a change in the QUANTITY demanded. The Law of Demand states that as price goes up, demand goes down.

Demand Schedule Table showing what price potential buyers would buy a product/service during a particular time P = price Q = # items consumers would buy at that price PQ (in thousands) $1400 $1205 $10010 $5020 $035

Demand Curve Curve that represents a demand schedule What happens to the price as the quantity goes up? Vice versa?

CHANGE IN QUANTITY DEMANDED VS. A CHANGE IN DEMAND This is a very important concept and one you must know by heart. A change in quantity demanded is caused by a change in price. Higher price, lower demand and vice versa. This causes movement along the demand curve itself. The movement may be up or down the curve. A change in demand causes a shift of the entire demand curve. These changes are caused by shifters or determinants.

Shifters or Determinants If the following create a shift of the demand curve to the left it is a decrease. If they create a shift to the right it is an increase. Memorize that leftward movement is a decrease and rightward movement is an increase. This will be less confusing than learning it as up and down.

DETERMINANTS OR SHIFTERS #1. Changes in Consumer Tastes A change in consumer tastes – what if you found out oranges could prevent cancer? A change in the number of buyers – which way is the shift if the population suddenly decreases for some reason? What if the population increases? Suggest some other changes…

DETERMINANTS - #2 CHANGES IN CONSUMER INCOME Changes in consumer income change the demand for … Normal Goods v. Inferior Goods  Normal Goods are your first choice  Inferior goods are what you settle for.

#2 Income changes While you are in school and your income is low you might want the bike. You graduate and start climbing the corporate ladder – time for the SPORTS CAR. – income up – normal good is chosen The sports car is your normal good because it is your preference. If you lose your job – income down – inferior good is chosen – bike.

Movements on a Graph Income changes and resultant shifts can be shown on a demand graph. Draw a demand curve for a bike as a student would experience it. Show the shift in demand when the student gets a good- paying job. Do the same thing for the sports car. When did you shift left, when did you shift right on these two items.

DETERMINANTS - #3 COSTS OF RELATED GOODS: COMPLEMENTS

COMPLEMENTS A RELATED GOOD Complements are goods that go together:  Shoes and Socks  Bread and Butter  Camera and Film A change in the cost of one good causes a change in demand for the other. Demand moves opposite of cost of the other product. Price down, demand up and vice versa.

DETERMINANTS #3 COSTS OF RELATED GOODS: SUBSTITUTES

SUBSTITUTES ANOTHER RELATED GOOD Substitutes can be used in place of another good – just like a substitute teacher. – Margarine for Butter – Hamburger for Steak – Tea for Coffee When the cost of one rises the demand for the other good changes in the same direction. Cost of butter goes up; therefore, the demand for margarine (the cheaper product) goes up.

GRAPHING CHANGES Think about the law of demand: Price Up, Demand Down or Price Down, Demand Up Consider Complements: If the price of coffee goes up and you like donuts with your coffee, what happens to the demand for donuts. What might be another example?

GRAPHING CHANGES Now consider substitutes. – You like steak but you lose your job, income change, what can you substitute? » Or – You are a student who has been eating hotdogs and beans. You graduate and get a job. What will you choose now? – Graph the changes making sure you completely label your graph.

DETERMINANTS #4 POPULATION CHANGES Changes in the number of buyers will also shift the demand curve. – Population up – demand shifts right – Population down – demand shifts left

Equilibrium Price the price at which the quantity of a product offered is equal to the quantity of the product in demand

Key Results of Shifts in Demand If an event increases demand, the demand curve will shift outward and to the right. If the supply curve is not affected, the equilibrium price and quantity will increase.

Key Results of Shifts in Demand If an event decreases demand, the demand curve will shift inward and to the left. If the supply curve is not affected, the equilibrium price and quantity will decrease.

Elasticity A measure of the degree of responsiveness of one variable to changes in another Used by companies to maximize their profits (i.e. OPEC)

Price elasticity of demand relative degree of responsiveness of the quantity demanded to relatively small changes in its price Slope of a demand curve is steep, then an increase in price won’t change demand much (inelastic demand – table salt) Slope of a demand curve is shallow, increase in price will drastically change demand (elastic demand - house)

Price Elasticity of Demand Ed = (% change in quantity demanded of X)/(% change in the price of X) Ed = (change Q/Q) * (change P/P) E is less than 1 = inelastic E greater than 1 = elastic

Example: CD sales Want to calculate the price elasticity CD sales at $12. E = ((Q1-Q0)/Q0)/((P1 P0)/P0) E = (( )/1000))/((13-12)/12) E= /0.083 E = -0.9 Elastic or inelastic? PriceQuantity Demand (per month) $111,100 $121,000 $13925

Example: CD sales: Answer E = (( )/1000))/((13-12)/12) E= /0.083 E = -0.9 Elastic or inelastic?

Unit Elasticity Any percentage change in demand is answered by an equal percentage increase in price Example: A card is $1 at 1Million demand. At $1.50, demand is 1.5 million. At 50 cents, demand is 500 thousand.

Perfectly Elastic Demand For a given demand, price does not change. E = Infinity Anything above a certain price, demand will be zero. At or below that price, there is no limit to demand.

Perfectly Inelastic Demand For a given price, demand does not change. E = 0

Homework 1. Draw the demand curve. Determine the elasticity at each price. At what price(s) is the ice cream inelastic? At what price(s) is the ice cream elastic? Price ($)Demand (millions)

Homework #2. Draw an approximate graph of unit elasticity, perfect inelasticity, and perfect elasticity. #3. Would you prefer your product to be elastic or inelastic? Why?