Demand Economics – Chapter 3

Demand  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. It is more than just the desire to purchase a product.

 The two important conditions are: 1.The consumer must be willing and able to buy the good or service. 2.The demand for the product must be examined for a specific time period (day, week, month, year, etc.)

Law of Demand  States that an increase in a good’s price causes a decrease in the quantity demanded and a decrease in price causes an increase in the quantity demanded.

Example:  You expect to buy an ipod for $200, and you have saved that amount. At the store, you discover that the price of the ipod has increased from $200 to $300. Even if you were able to pay the higher price, you might not be willing to do so. Some other consumers also will be unwilling or unable to pay the higher price. In other words, the price increase will lead to a decrease in the quantity demanded

 Two economic concepts help explain the Law of Demand:

1. Income Effect  The amount of money, or income, that people have available to spend on goods and services is called their purchasing power – as a consumer’s purchasing power increases, his or her demand for goods and services also tends to increase (and vice versa)  Any increase or decrease in consumers’ purchasing power caused by a change in price is called the income effect.

Income Effect Example:  If a store lowers the price of its CDs from $15 to $10, a consumer can buy more CDs with the same amount of money. A person spending $30 can buy 3 CDs at the new price of $10, but could have purchased only 2 CDs at the previous price of $15. The lower price increases the consumer’s purchasing power and increases the quantity of CDs demanded from 2 to 3.

2. Substitution Effect  The substitution effect describes the tendency of the consumers to substitute a similar, lower-priced product for another product that is more expensive.

Substitution Effect Example:  When the price of steak increases, many consumers reduce the quantity of beef demanded and buy more chicken, a lower-priced substitute.

 There are 2 ways to show the relationship between the price of a good or service and the quantity that consumers demand: 1.Demand Schedule – this information lists the quantity of goods that consumers are willing and able to buy at a series of possible prices. 2.Demand Curve – plots information, often from a demand schedule, on a chart.

 Because markets do not stand still, demand curves will shift to the left (decrease in demand) or the right (increase in demand) over a given time period.

Shifts in demand are caused by: 1.Consumer taste and preferences 2.Market size 3.Income 4.Prices of related goods or services 5.Consumer expectations