Chapter 3 DEMAND

Definitions and Concepts of Demand  Demand: The amount of a good or service that a consumer is WILLING and ABLE to buy during a given period of time. Effective demand

Definitions and Concepts of Demand  Quantity Demanded – the amount of a good or service that a consumer is willing and able to buy at EACH particular price during a given period of time.

Definitions and Concepts of Demand  Law of Demand – As prices go down, quantity demanded goes up. INVERSE RELATIONSHIP

Substitution Effect  Tendency of consumers to substitute a similar, lower priced product for another product that is more expensive. Butter for margarine Chicken for steak Plain label for name brand

Substitution Effect  Explains why a higher price causes a decrease in the quantity demanded.

Substitution Effect  BUT: If a good is seen as essential and there is no readily available substitute – People will continue to buy the same amount. Gas? Milk? Coke v. Pepsi?

Income Effect  Purchasing Power: The amount of money available to spend on goods and services.  BUT: any increase or decrease in consumers’ purchasing power caused by a change in price is the INCOME EFFECT

Income Effect Homers lowers the price of CDs from $15 to $10 – the consumer can buy more CDs with the same amount of income.

Income Effect in Reverse  The price of the CDs jumps to $20 and a consumer with $30 to spend, can now only buy one. Purchasing power is down.

Income Effect  Strong and predictable influence on the quantity demanded. BUT: Consumers may be ABLE to buy 3 CDs at $10, but they may still only be WILLING to buy 2. EFFECTIVE demand

Definitions and Concepts  Diminishing Marginal Utility – DMU: Usefulness of a product (utility).  Typically utility goes up as more product is consumed.  BUT: More units may be consumed, but satisfaction diminishes with more and more consumption

Demand Schedule  Shows quantities demanded at VARIOUS prices on a schedule.

Demand Curve  Shows all prices and quantities demanded in a graph.

Demand Curve Changes  Increases in demand move the curve to the right.

What Changes Demand?  Tastes and Preferences  Income  Market Size  Consumer expectations  Price of related goods Complements Substitutes

Substitute Goods  Goods that can be used to replace the purchase of similar goods when prices rise.

Complementary Goods  Goods that commonly used with other goods.  If paint goes on sale, the demand for paintbrushes goes up.  McDonalds meals

Consumer Expectations  Expectations of future income cause shifts in demand. Income goes up with a promotion / new job. Expecting to lose your job – tighten up and demand less.

Elasticity of Demand  People buy more at lower prices.  BUT We respond to some sales more than others.

Elasticity = Responsiveness  Certain goods tend to have ELASTIC demand if: The product is NOT a necessity. There are readily available substitutes Products cost represents a large portion of consumer income.

Elasticity = RESPONSIVENESS  A SMALL decrease in a good’s price causes a SIGNIFICANT increase in the quantity demanded.

ELASTIC DEMAND  Pizza is considered ELASTIC DEMAND. It is NOT a necessity. Readily available substitutes. Cost of the product compared to consumers’ income. For you, a sale on pizza is a bigger deal than for adults with full time jobs.

Elastic Demand  Curves tend to be FLATTER if demand is ELASTIC.  EEEEEE

Inelastic Demand = Unresponsive  Inelastic Demand exists when a change in a good’s price has LITTLE impact on the quantity demanded.

Inelastic Demand = Unresponsiveness  Inelastic Demand IF Product is a necessity There are few or no readily available substitutes for the product The product’s costs represents a small portion of consumer’s income.

Inelastic Demand Products  Salt  Soap  Insulin  Gas

REMEMBER!  Inelastic Demand curves tend to be more vertical.  IIIIIII  I nsulin

Measuring Elasticity  Business people need to be able to measure demand elasticity for their goods and services.

Measuring Elasticity  Total Revenue Test  Total Revenue = total income the business receives from selling its products. Sometimes called total receipts.

Measuring Elasticity  By measuring any changes in a business’s total revenue before and after changes in the price of a product you can determine elasticity of demand for the product.

Total Revenue and Elastic Demand  A drop in a business’s total revenue from a price increase indicates elastic demand.  Changing movie ticket prices from $4 to $5.

Total Revenue and Inelastic Demand  A rise in a business’s total revenue because of a price increase indicates inelastic demand. Say the ticket prices went from $3 to $4.

Maximizing Total Revenue – When did the theater get the maximum profit?

NON PRICE Determinants of Demand  New advertisements  Government policy decisions Taxing imports or adding sales taxes  Changes of technology.

Questions to Answer  Define elasticity of demand.  Define Elastic Demand  Define Inelastic Demand  Define total revenue.  Can you name items with elastic demand? Inelastic demand?

Questions to answer  Why is determining demand elasticity important in economics?  How can a product have both elastic and inelastic demand? Example not used in book???