Transcript Unit III Review

Unit III Review
CHAPTERS 4-6
SUPPLY & DEMAND
4.1 Understanding Demand
 Demand: the desire to own something and the
ability to pay for it.
 The law of demand: consumers buy more of a
good when its price decreases and less when its price
increases.
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The result of two patterns of behavior that overlap.
Substitution effect: When consumers react to an increase in
a good’s price by consuming less of that good and more of
other goods.
Income effect: the change in consumption resulting from a
change in real income.
4.1 Understanding Demand
 The Income Effect
 Rising prices make us feel poorer because you can no longer
buy the same combination of goods you once did.
 Effect is seen when you buy fewer units of a good without
increasing your purchases of other goods.
 Economists measure consumption in the amount of a good
that is bought, not the amount of money spent to buy it.
 With rising prices, you are spending more on a good, but you
are consuming less of it.
 Income effect also operates when prices decline.
4.1 Understanding Demand
 Demand Schedule: A table that lists the quantity
of a good a person will buy at each different price.
 Market demand schedule: a table that lists the
quantity of a good all consumers in a market will buy
at each different price.
4.1 Understanding Demand
 Demand curve: a graphic representation of a
demand schedule
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Vertical axis is always labeled with the prices and the
horizontal axis is always labeled with the quantity demanded.
Only shows the relationship between price and quantity
demanded- all other factors are held constant.
The curve slopes downward to the right to show that as the
price decreases, the quantity demanded increases.
4.2 Shifts of the Demand Curve
 Ceteris paribus: all other things held constant
 A demand curve is only accurate as long as it is only
price that is changing.
 A movement along the demand curve due to a
change in price is a change in quantity demanded.
 When a factor other than price changes the quantity
demanded, it shifts the entire curve, referred to as a
change in demand.
 Shift right = increase in demand; shift left = decrease
in demand
4.2 Shifts of the Demand Curve
 Income
 Normal good: a good that consumers demand more of when
their income increases.
 Inferior good: a good that consumers demand less of when
their income increases.
 Consumer Expectations
 Our expectation of the future can affect our demand for certain
goods today.
 If you expect higher prices in the future, your immediate
demand will increase.
 If you expect lower prices in the future, your immediate
demand will decrease.
4.2 Shifts of the Demand Curve
 Related Goods
 Complements: two goods that are bought and used together.
If the price of a good increases, the demand for it and its
complement(s) will fall and vice versa.
 Substitutes: goods used in place of each other. If the price of
a good increases, the demand for its substitute(s) will increase
and vice versa.
 Preferences
 Advertising, social trends, celebrities, tv and movies, publicity
 Market Size (Population)
 An increase in market size will lead to an increase in demand
for most goods and vice versa.
4.3 Elasticity of Demand
 Elasticity of demand: a measure of how
consumers react to a change in price.
 Inelastic: describes demand that is not very
sensitive to a change in price.
 Elastic: describes demand that is very sensitive to a
change in price.
 Calculating elasticity
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Percentage change in demand of good/percentage change in
price of demand
Percentage change = ([original number – new
number]/original number) x 100
4.3 Elasticity of Demand
 Price Range
 Demand for a good can be highly elastic at one price and
inelastic at a different price.
 Values of Elasticity
 If the elasticity of demand for a good at a certain price is less
than 1, demand is inelastic.
 If the elasticity is greater than 1, demand is elastic.
 Unitary elastic: describes demand whose elasticity is exactly
equal to 1.
 When elasticity of demand is unitary, the percentage change in
quantity demanded is exactly equal to the percentage change
in price.
4.3 Elasticity of Demand
 Factors Affecting Elasticity
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Availability of substitutes: lack of substitutes can make demand
inelastic and a variety of substitutes can make demand elastic.
Relative importance: if you spend a large portion of your budget on a
good, a price increase will make your demand elastic. If it is a small
percentage of your budget, your demand is probably inelastic.
Necessities vs. luxuries: people will always buy necessities, even
when price increases (inelastic). Luxuries are elastic as they are easy
to reduce the quantity demanded.
Change over time: consumers cannot respond quickly to price
changes, making their demand inelastic in the short term. Over time,
they find substitutes and their demand becomes elastic.
4.3 Elasticity of Demand
 Total revenue: the total amount of money a firm
receives by selling goods or services.
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Price x quantity sold
When a good has an elastic demand, raising the price will
decrease the quantity sold by a larger percentage, which can
reduce a firm’s total revenue.
When demand is inelastic, higher prices make up for lower
sales, increasing a firm’s total revenue.
A firm makes pricing decisions based on the elasticity of its
good(s).