1. 1 Module 2: Market Mechanism - Demand Objectives: demandquantity  Understand the difference between demand and quantity demanded demanded. law of demand,  Define and explain the law of demand, and the two reasons why a demand curve usually slopes downwards. change in demand  Understand the difference between a change in demand change in quantity demanded and a change in quantity demanded. shift  Understand what causes demand to shift.

2. 2 Understand the difference between demand and quantity demanded. demand curve  A demand curve shows quantities demanded by a consumer at various prices. Objective 1 Price per cup ($) Quantity Demanded (cups of coffee) 1.0010 2.009 3.008 4.007 5.006 6.005 7.004 8.003 9.002 10.001

3. 3 3 Quantity demanded particular  Quantity demanded is the amount of a product that a consumer is willing and able to purchase at a particular price. Demand versus Quantity Demanded:  Demand versus Quantity Demanded: Demand refers to the entire curve while quantity demanded is associated with a point on the curve.

4. 4 Define and explain the law of demand, and the two reasons why a demand curve slopes downwards. Law of Demand  The Law of Demand states that holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase and when the price of a product rises, the quantity demanded of the product will decrease.  When the price of a good changes, there are two effects: substitution effect (i) the substitution effect of a price change, and income effect (ii) the income effect of a price change. Objective 2

5. 5 5  The substitution effect is the change in quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods that are substitutes.  The income effect is the change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumer purchasing power. The Law of Demand is explained by the income and substitution effects of a price change.

6. 6 Do Not Confuse the substitution effect of a price change with the change in the price of a substitute good. The substitution effect of a price change explains a movement along the curve. Specifically, we’re asking the question: Now that the price of good X has gone up, it is more expensive relative to other goods that can substitute for X and so will this “relative price effect” change the amount of X that I want to buy? 6

7. 7 7 Do Not Confuse the income effect of a price change with the effect of a change in income. The income effect of a price change, explains a movement along the curve. Specifically, we’re asking the question: Since the price of X has gone up, it essentially reduces my purchasing power and how will this affect the quantity demanded of X? The income and substitution effects of a price change are shown as a movement along the demand curve.

8. 8 Understand the difference between a change in quantity demanded and a change in demand.  A change in quantity demanded refers to a movement along a demand curve in response to a price change. Objective 3 A change in price causes a movement along a demand curve.

9. 9  An increase in demand is represented by a rightward shift of the demand curve. A change in demand occurs when the entire demand curve shifts.

10. 10  A decrease in demand is represented by a leftward shift of the demand curve. Change in demand ……..entire curve shifts.

11. 11 Understand what causes demand to shift 1. The price of the product 2. Tastes and preferences of buyers 3. Income of buyers 4. Price of related goods, namely substitutes and complements 5. Number of buyers or Population Determinants of Demand include: Objective 4 6. Consumers’ expectations about the future for example, about future prices and future income 7. Government policies that affect consumption 8. Special Influences such as dating patterns, availability of subways and festive seasons change in any determinant  A change in any determinant other than price causes a shift of the demand curve.

12. 12  Ceteris paribus (“all else constant”) is the requirement that when analyzing the relationship between two variables – such as the price and quantity demanded – other variables must be held constant. A change in any determinant other than price causes a shift of the demand curve. Price and quantity demanded change along a demand curve. All other determinants are held constant

13. 13 Examples of Demand Shifters: Change in income Example 1: Suppose Janet’s income increases. How does this affect her demand for coffee?  It depends on whether the good is a normal good or an inferior good.  Normal goods: demand increases as income rises and decreases as income falls. Examples include concert tickets and restaurant meals. Coffee is a normal good

14. 14 A  Inferior goods: demand decreases as income rises, and increases as income falls. Examples include laundromat services and bus rides. Coffee is an inferior good

15. 15 A  Note: Normal and Inferior goods are defined in terms of the relationship between income and demand.  The question you need to ask is: What happens to my demand for good X when my income increases or decreases?  The quality of the product is irrelevant when defining a product as “normal” or “inferior”.  A product may be normal to one person and inferior to another. Normal and Inferior Goods

16. 16 Demand Shifter: Change in the price of a related good There are two types of goods related in consumption:  A Substitute in consumption is a product that is consumed in place of another. For example, coffee and tea, Coke and Pepsi.  A Complement in consumption is a product that is consumed together with another product, For example, bagel and cream cheese, printer and ink cartridge.

17. 17 Example 2: Suppose to Janet coffee and tea are substitutes. What happens to her demand for coffee when the price of tea falls?  A decrease in the price of tea causes the quantity demanded of tea to increase.

18. 18  In the coffee market, Janet’s demand decreases causing the coffee demand curve to shift left.

19. 19 Definition of Substitutes in Consumption  Two goods, C and T are substitutes in consumption if an increase in the price of good T (P T ) leads to a increase in the demand for good C (D C ), and a decrease in the price of good T (P T ) leads to a decrease in the demand for good C (D C ), i.e., there is a positive relationship between price of good T and the demand for good C.

20. 20 Demand Shifter: Change in consumers’ expectations about future prices Example 3: Suppose consumers expect the price of silver to fall next month. How does this affect the demand for silver today?  Today, demand decreases in anticipation of lower prices in the future. Today’s demand curve with some given set of expectations about price Today’s demand curve with a new set of expectations about price Today’s price