1. Unit 2: Supply, Demand, and Consumer Choice

2. The Circular-Flow Diagram
Product Market 1 2
What flow are the following?
A. Consumer spending?
B. Goods and services?
C. Land, labor, capital,
and entrepreneurs?
D. Rent, income, interest,
and profits? 2 1 4 3
Businesses
Households
Labor 3 4
Resource Market 5

3. A. In the product market (householders/businesses) are the
demanders and (householders/businesses) are the suppliers.
B. In the resource market (householders/businesses) are the
C. In the resource market, (householders/businesses)
sell resources to (householders/businesses).
D. In the product market, (householders/businesses) sell
products goods/services to (householders/businesses).

6. I am willing to sell several A’s in this class. How much will you pay?
Example of Demand
I am willing to sell several A’s in this class. How much will you pay?
Price
Quantity
Demanded
Demand Schedule

7. DEMAND DEFINED What is Demand? What is the Law of Demand?
Demand is the different quantities of goods that consumers are willing and able to buy at different prices.
(Ex: Bill Gates is able to purchase a Ferrari, but if he isn’t willing he has NO demand for one)
What is the Law of Demand?
There is an INVERSE relationship between price and quantity demanded

8. LAW OF DEMAND As Price Falls… …Quantity Demanded Rises As Price Rises…
…Quantity Demanded Falls
Quantity Demanded
Price

9. Why does the Law of Demand occur?
The law of demand is the result of three separate behavior patterns that overlap:
The Substitution effect
The Income effect
The Law of Diminishing Marginal Utility
We will define and explain each…

10. Why does the Law of Demand occur?
1. The Substitution Effect
If the price goes up for a product, consumer buy less of that product and more of another substitute product (and vice versa)
2. The Income Effect
If the price goes down for a product, the purchasing power increases for consumers -allowing them to purchase more.

11. Why does the Law of Demand occur?
3. Law of Diminishing Marginal Utility U-
TIL-
IT- Y
Utility = Satisfaction
We buy goods because we get utility from them
The law of diminishing marginal utility states that as you consume more units of any good, the additional satisfaction from each additional unit will eventually start to decrease
In other words, the more you buy of ANY GOOD the less satisfaction you get from each new unit.
Discussion Questions:
What does this have to do with the Law of Demand?
How does this effect the pricing of businesses?

12. Can you see the Law of Diminishing Marginal Utility in Disneyworld’s pricing strategy?
Change
N/A
$100.11
$91.81
$21.30
$10.65

13. The Law of Diminishing Marginal Utility

14. Graphing Demand

15. Let’s draw a new demand curve for cereal…
The Demand Curve
A demand curve is a graphical representation of a demand schedule.
The demand curve is downward sloping showing the inverse relationship between price (on the y-axis) and quantity demanded (on the x-axis)
When reading a demand curve, assume all outside factors, such as income, are held constant. (This is called ceteris paribus)
Let’s draw a new demand curve for cereal…

16. GRAPHING DEMAND Draw this large in your notes Demand Schedule
Price of Cereal
Draw this large in your notes $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80 o Q
Quantity of Cereal

17. GRAPHING DEMAND Demand Schedule Price of Cereal $5 10 $4 20 $3 30 $2
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand o Q
Quantity of Cereal 17