Transcript The Economic Way of Thinking 10e ©Prentice Hall 2003 Demand

“The Economic Way of Thinking”
10th Edition
by Paul Heyne, Peter Boettke,
and David Prychitko
“Substitutes Everywhere:
The Concept of Demand
PowerPoint Slides
prepared by
Assistant Professor
Paul Harris
Camden County College
The Economic Way of Thinking 10e
©Prentice Hall 2003
1
Chapter Outline
I.
II.
III.
IV.
V.
VI.
Introduction
On the Notion Of “Needs”
The Concept of Demand
Marginal Values
Decisions at the Margin
Making it Graphic
2
The Economic Way of Thinking 10e
©Prentice Hall 2003
Chapter Outline
Chapter
Outline
VII. Demand and Quantity Demanded
VIII.The Difference It Makes
IX. Law of Demand: A Summary
X. Misperceptions caused by Inflation
XI. Time is on Our Side
XII. Price Elasticity of Demand
XIII.Thinking about Elasticity
3
The Economic Way of Thinking 10e
©Prentice Hall 2003
Chapter Outline
Chapter
Outline
XIV.Elasticity and Total Receipts
XV. The Myth of Vertical Demand
XVI. All Scarce Goods Must be Rationed
Somehow
XVII. Money Cost and Other Cost
XVIII. Once Over Lightly
4
The Economic Way of Thinking 10e
©Prentice Hall 2003
Introduction
•Most goods are scarce.
– Sacrifice is necessary.
•There are substitutes for everything.
•Intelligent choice entails trade-offs.
•Market price signals encourage buyer to
economize
5
The Economic Way of Thinking 10e
©Prentice Hall 2003
Introduction
•What is wrong with the following
statements?
1) Fire safety requires that there be two
exits from each apartment unit.
2) We need a new car.
6
The Economic Way of Thinking 10e
©Prentice Hall 2003
On the Notion of “Needs”
•What is the
relationship between
“tradeoffs” and
“needs”?
•Consider these four
statements………
All of these
statements have
necessity in
common.
The Economic Way of Thinking 10e
1. The average person
needs eight glasses of
water per day to
maintain good health.
2. All citizens should be
able to obtain the
medical care they need
regardless of their
ability to pay.
3. A diabetic needs
insulin.
4. You need to read your
economics textbook. 7
©Prentice Hall 2003
On the Notion of “Needs”
Higher prices (sacrifices) lead people to
seek substitutes.
The fact that goods and services are
scarce entails tradeoffs, i.e., the sacrifice of
other goods and services that we value.
8
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Concept of Demand
Demand
Relates amounts people want to obtain
to the sacrifices they must make
When a want can only be satisfied at
some cost we accept less.
9
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Concept of Demand
“Law of Demand”
A negative relationship exists between the
amount of anything that people want to
purchase and the price they must pay.
10
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Concept of Demand
Question: Are there any exceptions to the Law of
Demand?
“Let’s stock up before the price goes even
higher.”
Answer: Alleged exceptions are based on
misinterpretation of the evidence.
Expectations of future price increases
encourages people to buy more now, so that
they can buy less later at the higher price. 11
The Economic Way of Thinking 10e
©Prentice Hall 2003
Marginal Values
Questions
Which is more valuable, water or diamonds?
Which is more valuable, a glass of water or a
glass of diamonds?
Answers:
The values that matter are marginal values
Marginal means “additional”, so in
economics we make decisions based on
expected marginal benefits, versus marginal
cost.
12
The Economic Way of Thinking 10e
©Prentice Hall 2003
Decisions at the Margin
•Decisions are not made in terms of “all or
nothing.”
•The “Economic Way of Thinking”….
– Measures the change in one alternative,
versus the change in another, compared to
the original state of affairs.
– Marginal decision making is true for people
who economize on any scarce food,
including a basic “necessity” such as water.
13
The Economic Way of Thinking 10e
©Prentice Hall 2003
Making It Graphic
Graphs can be used to illustrate
relationships.
Demand Curves
Illustrate the relationship between price
and quantity demanded
14
The Economic Way of Thinking 10e
©Prentice Hall 2003
Making It Graphic
Price per Gallon
$.07
.04
.02
.01
.005
Gallons per Day
25
40
80
160
320
Demand Schedule is a tabular representation of graphical data:
15
The Economic Way of Thinking 10e
©Prentice Hall 2003
Making It Graphic
$.07
PRICE PER GALLON
.06
.05
.04
.03
.02
.01
.00
0
40
80
120
160
200
240 280
320
GALLONS OF WATER PER DAY
The Economic Way of Thinking 10e
©Prentice Hall 2003
360
400
16
Making It Graphic
Economic theory assumes:
Households compare price with its “utility.”
Consumption decreases when marginal
benefit is less than the price.
Total usefulness is the area under the
curve.
17
The Economic Way of Thinking 10e
©Prentice Hall 2003
Demand and Quantity Demanded
“A change in demand” is not the same
thing as a “change in quantity demanded”.
Demand is a relationship between two
specific variables.
It is a schedule or a curve.
P
Change in Quantity demanded:
Change in demand::
P
D2
D
D1
Q
Q
The Economic Way of Thinking 10e
©Prentice Hall 2003
18
Demand and Quantity Demanded
Price
Quantity
Demanded
50 cents
40
30
125,000
160,000
175,000
19
The Economic Way of Thinking 10e
©Prentice Hall 2003
Demand and Quantity Demanded
•A change in quantity demanded is a
movement from one point on a curve to
another point on the same curve.
•A change in demand results from some
other factor that makes households buy
more at each price.
– The demand curve shifts.
20
The Economic Way of Thinking 10e
©Prentice Hall 2003
Demand and Quantity Demanded
Price per Gallon
Original Gallons/Day
New Gallons/Day
$.07
25
40
.04
40
60
.02
80
140
.01
160
240
.005
320
400
21
The Economic Way of Thinking 10e
©Prentice Hall 2003
Demand and Quantity Demanded
$.07
PRICE PER GALLON
.06
.05
.04
.03
.02
.01
.00
0
40
80
120
160
200
240 280
320
GALLONS OF WATER PER DAY
The Economic Way of Thinking 10e
©Prentice Hall 2003
360
400
22
Demand and Quantity Demanded
Price
Per
Gallon
Original
Gallons/
Day
New
Gallons/
Day
$.07
25
15
.04
40
25
.02
80
55
.01
160
100
.005
320
200
23
The Economic Way of Thinking 10e
©Prentice Hall 2003
Demand and Quantity Demanded
$.07
PRICE PER GALLON
.06
.05
.04
.03
.02
.01
.00
0
40
80
120
160
200
240 280
320
GALLONS OF WATER PER DAY
The Economic Way of Thinking 10e
©Prentice Hall 2003
360
400
24
The Difference It Makes
•An editorial in The Wall Street Journal
incorrectly stated,
– “The coffee market is behaving the way the
basic textbooks say a market behaves:
Prices go up, demand falls, and prices come
down.”
•Price and quantity demanded move in
opposite directions.
25
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Difference It Makes
Demand for a good is a function of:
Biological realities
Social relationships
Psychological factors
Economic variables
Income
Substitutes
26
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Difference It Makes
D1
P
D2
A fall in
the demand
Q
27
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Difference It Makes
P
D
P2
Price goes up,
quantity
demanded goes
down,
period!
P1
Q2
The Economic Way of Thinking 10e
Q1
Q
©Prentice Hall 2003
28
The Difference It Makes
P
Demand for bicycles:
effect of a lower
price
Q
29
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Difference It Makes
P
Demand for bicycles:
effect of
environmental
concern
Q
30
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Law of Demand
A Summary
•Other things constant,
if the price of a good
changes, the quantity
demanded changes.
•A higher price
decreases quantity
demanded.
•A lower price
increases quantity
demanded.
• A change in price
causes movement
along a stable demand
curve.
•When something
other than price
changes, the whole
demand curve changes
(shifts) either to the
right (increase), or to
the left (decrease).
31
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Law of Demand
A Summary
Changes in consumer
The non-price
taste and preferences.
determinants of
Changes in incomes.
demand that
encourage consumers Changes in the price of
other goods and services.
to buy more or less
are………
Changes in
expectations.
Demand can increase
or decrease because of
these factors.
32
The Economic Way of Thinking 10e
©Prentice Hall 2003
Time Is On Our Side
Changes in the quantity demanded takes
time.
These changes will be greater for any
price change the longer the time period
allowed for adjustment.
It takes time for customers to find and
begin to use substitutes.
It also takes time for producers to devise,
produce, and publicize substitutes.
33
The Economic Way of Thinking 10e
©Prentice Hall 2003
Price Elasticity of Demand
Price elasticity of demand measures consumer
responsiveness to price changes.
Inelastic Demand
If quantity demanded changes very little as
a result of a large change in price.
Elastic Demand
If quantity demanded changes substantially
as a result of a small change in price.
34
The Economic Way of Thinking 10e
©Prentice Hall 2003
Price Elasticity of Demand
% change in Q
Price elasticity of demand =
% change in P
.5
E P   2.5
.2
35
The Economic Way of Thinking 10e
©Prentice Hall 2003
Price Elasticity of Demand
Example
Price increases by 20%
Quantity demanded decreases by 50%
Consumers are relatively responsive
Elastic
Example
Price decreases by 20%
Quantity demanded increases by 15%
Consumers are relatively unresponsive
Inelastic
The Economic Way of Thinking 10e
©Prentice Hall 2003
36
Price Elasticity of Demand
Elastic Demand
Price elasticity > 1
Inelastic Demand
Price elasticity < 1
Unit Elastic
Price elasticity = 1
37
The Economic Way of Thinking 10e
©Prentice Hall 2003
Thinking About Elasticity
“People aren’t going to buy much more no
matter how far we cut the price.”
“This is a competitive business. We would lose
half our customers if we raised our prices by as
little as 2 percent.”
The answer
Question
is no to both
Would a firm want to lower
price if demand were
questions.
inelastic?
Question
Would a firm want to raise price if demand were
elastic?
38
The Economic Way of Thinking 10e
©Prentice Hall 2003
Thinking About Elasticity
P
D
Inelastic Demand
Q
39
The Economic Way of Thinking 10e
©Prentice Hall 2003
Thinking About Elasticity
P
Elastic Demand
D
Q
40
The Economic Way of Thinking 10e
©Prentice Hall 2003
Thinking About Elasticity
•Question
– Can food stores charge any price they want
since they sell food?
•Question
– Would it be wise to impose a tax on table salt?
•Question
– Would the demand for Morton’s salt be more
elastic or inelastic than the demand for salt?
41
The Economic Way of Thinking 10e
©Prentice Hall 2003
Thinking About Elasticity
A product’s elasticity depends upon….
The proportion of one’s budget spent on
an item. The more a product takes of your
budget, the more elastic.
The more substitutes a product has, the
more elastic.
Necessities are less elastic than luxuries.
All products become more elastic with time.
42
The Economic Way of Thinking 10e
©Prentice Hall 2003
Elasticity and Total Receipts
“The university’s total receipts from
tuition would actually increase if tuition
rates were cut by 20 percent.”
The 20 percent cut in prices must cause
quantity demanded to increase by more
than 20 percent.
Elastic demand
43
The Economic Way of Thinking 10e
©Prentice Hall 2003
Elasticity and Total Receipts
“It’s odd but true. Wheat farmers would
gross more money if they all got together
and burned one-quarter of this year’s crop.”
Elastic Demand
Prices and total receipts move in
opposite directions.
Inelastic Demand
Prices and total receipts move in the
same direction.
44
The Economic Way of Thinking 10e
©Prentice Hall 2003
Elasticity and Total Receipts
P
Elastic demand
between C and E
since OBCG < OAEF.
B
C
E
A
O
D
G
F
Q
45
The Economic Way of Thinking 10e
©Prentice Hall 2003
Elasticity and Total Receipts
P
Inelastic demand
between A and B.
B
A
D
Q
46
The Economic Way of Thinking 10e
©Prentice Hall 2003
Elasticity and Total Receipts
P
Demand for wheat
The price when
1/4 of crop is burned.
The market price
when entire crop is sold
Q
47
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Myth of Vertical Demand
P
P1
D
P2
Q
48
The Economic Way of Thinking 10e
©Prentice Hall 2003
The Myth of Vertical Demand
Question
Does a perfectly inelastic demand curve exist?
Will consumers buy the same quantity at all
prices?
There is no such thing as a completely inelastic
demand curve over the entire possible range of
prices.
If the price of insulin falls diabetics would be more
likely to purchase a larger quantity, implying that
the demand curve for insulin is downward sloping.
The Economic Way of Thinking 10e
©Prentice Hall 2003
49
All Scarce Goods must be
Rationed Somehow
Market prices and willingness to pay are our
primary criteria for rationing goods and
services.
If a good is scarce, sacrifices must be made to
obtain it.
When prices of products and services rise,
people respond by economizing in their use.
People naturally find ways to economize that entail
the least sacrifices.
50
The Economic Way of Thinking 10e
©Prentice Hall 2003
All Scarce Goods must be
Rationed Somehow
Scarce goods must be rationed.
Rationing can be done by willingness to pay
prices.
Other ways to ration:
“First come, first served”
Lottery
Equal shares for all
“Might makes right”
Merit
51
The Economic Way of Thinking 10e
©Prentice Hall 2003
Money Costs and Other Costs
People respond to changes in cost:
Explicit
Implicit
Money is a common denominator, a
yardstick, and a measure of value.
Changes in money prices are a useful
device for coordinating people’s behavior.
52
The Economic Way of Thinking 10e
©Prentice Hall 2003
Once Over Lightly
Tradeoffs
Scarcity
Substitutes
Marginalism
Needs
The Law of
Demand
Demand Schedule
Changes in
Demand
Non-Price
Determinants of
Demand
Rationing
Elasticity
53
The Economic Way of Thinking 10e
©Prentice Hall 2003
Next Chapter 4
Opportunity
Cost and the
Supply of Goods
End of Chapter 3