Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 4 Consumer Demand

What determines what we buy? – The Sociopsychiatric Explanation. – The Economic Explanation. Determinants of Demand 4-2

Sociopsychiatric Explanation The desire for goods and services arises from our needs for social acceptance (or envy), security, and ego gratification. – “Keeping up with the Joneses.” – Self-preservation. – Expressions of affluence. 4-3

The Economic Explanation Prices and income are just as relevant to consumption decisions as more basic desires and preferences. The willingness and ability to pay are critical. 4-4

Determinants of Demand Market demand for a specific product is determined by: – Tastes. – Income. – Expectations. – Other goods. – The number of consumers in the market. 4-5

Total Utility Utility is the pleasure or satisfaction obtained from a good or service. Total utility is the amount of satisfaction obtained from entire consumption of a product. 4-6

Marginal Utility Marginal utility is the change in total utility obtained by consuming one additional (marginal) unit of a good or service. 4-7

Figure

Law of Diminishing Marginal Utility The marginal utility of a good declines as more of it is consumed in a given time period. Suppose a student who enjoys popcorn can eat all he/she wants for free. – The first box consumed is very rewarding. – The third box is decent, etc. – After eating the sixth box, she gets sick. 4-9

As long as the marginal utility is positive, the consumer receives additional satisfaction and total utility increases. Additional quantities of a good yield increasingly smaller increments of satisfaction. Law of Diminishing Marginal Utility 4-10

Law of Demand The concepts of marginal utility and ceteris paribus explain the downward slope of the demand curve. With given income, tastes, expectations, and prices of other goods and services, people are willing to buy additional quantities of a good only if its price falls. 4-11

The higher the marginal utility, the more you are willing to pay. Diminishing marginal utility explains why price must decrease in order for you to continue to buy a good or service. Law of Demand 4-12

According to the law of demand, the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus, and vice versa. Law of Demand 4-13

Figure

The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Price Elasticity 4-15

The price of popcorn goes up 20% and the quantity demanded goes down 10%. The price elasticity of demand is: (E) = percentage change in quantity demanded percentage change in price = –10% 20% – 0.5 = Price Elasticity 4-16

Elastic Demand Demand is elastic if the absolute value of E is greater than 1. Consumer response is large relative to the change in price. – A 20% price rise generates a 30% decrease in quantity demanded. 4-17

Inelastic Demand Demand is inelastic if the absolute value of E is less than 1. Consumers are not very responsive to price changes. – A 20% price rise generates only a 10% decrease in quantity demanded. 4-18

Unitary Elastic Demand Demand is unitary elastic if the absolute value of E equals 1. The percentage change in quantity demanded is equal to the percentage change in price. – A 20% price rise generates a 20% decrease in quantity demanded. 4-19

Table

Price Elasticity and Total Revenue Price elasticity explains why producers cannot charge the highest possible price. Although one would think otherwise, higher prices may actually reduce total sales revenue. 4-21

Elasticity and Total Revenue A price cut decreases total revenue if demand is price inelastic (E < 1). A price cut increases total revenue if demand is price elastic (E > 1). A price cut does not change total revenue if demand is unitary elastic (E = 1). 4-22

Figure

Determinants of Price Elasticity Differences in price elasticity are explained by several factors: – Whether the Good Is a Necessity or Luxury – The Availability of Substitutes – The Price Relative to Income 4-24

Necessities versus Luxuries Some goods are so critical to our everyday life that we regard them as necessities. – We must buy even if the price goes up. Demand for necessities is relatively inelastic. 4-25

A luxury good is something we’d like to have but aren’t likely to buy unless our income jumps or the price declines sharply. – We will simply wait for a sale. Demand for luxury goods is relatively elastic. Necessities versus Luxuries 4-26

Availability of Substitutes If substitute goods are readily available, we can switch to the substitute. Demand for goods easily substituted for will be relatively elastic. If substitute goods are not readily available, we must stay with this good. Demand for goods with few substitutes will be relatively inelastic. 4-27

Price Relative to Income If the price of a product is very high relative to the consumer’s income, the demand will tend to be elastic. – We will put off the purchase until there is a sale. 4-28

Price Relative to Income If the price of a product is very low relative to the consumer’s income, the demand will tend to be inelastic. – We do not pay much attention to any price change. 4-29

Substitute and Complementary Goods Substitute Goods: The demand for a good increases when the price of a substitute for the good goes up. – We will switch from Starbucks to Dunkin’ Donuts. 4-30

Substitute and Complementary Goods Complementary Goods: The demand for a good decreases when the price of a complement to the good goes up. – As gas prices rise, people trade in SUVs for hybrids. 4-31

Changes in Income Income is a determinant of demand. – If our income rises, we can, and do, want to buy more products at any price. We illustrate income changes with shifts of the demand curve. 4-32