Chapter 4 Powerpoint

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Understanding Demand
Demand is the desire to own something and
the ability to pay for it
◦ Both of these conditions must be present
Law of Demand says that when a good’s price
is lower, consumers will buy more of it
◦ When the price is higher, consumers will buy less
◦ A price of a good will strongly influence your
decision to buy
The law of demand is a result of two separate
◦ Substitution effect and income effect
◦ Describes two ways that consumers changes his or
her spending patterns
◦ Together they explain why an increase in price
decreases the amount purchased
◦ Changes consumers buying habits
Substitution effect
◦ Takes place when a consumer reacts to a rise in
price of one good by consuming less of that good
and more of a substitute good
◦ Also applies to a drop in price
Income effect
◦ The change in consumption that results when a
price increase causes real income to decline
◦ Also works when prices drop
To have demand of a good, you must be able
to buy it at a specific price
◦ If you can’t afford a good, you don’t demand it
Demand schedule
◦ Is a table that lists the quantity of a good that a
person will purchase at various prices in a market
Price of a slice of pizza
Quantity demanded each
Market Demand Schedule
◦ When you add up the demand schedules of each
buyer in the market you create a market demand
Price of a slice of pizza
Quantity demanded per
Ceteris paribus is a Latin phrase for “all other
things are held constant
◦ The demand schedule for pizza only took into
account changes in price
◦ Didn’t take into account other factors like news
◦ Demand curve is only accurate if there are no other
changes but price
 Then it is just an increase or decrease in the quantity
When we drop ceteris paribus then the demand curve
◦ A shift in the curve means that at every price,
consumers buy a different quantity then before
◦ This is what economists call a shift in demand
◦ If an individual’s town is hit by a heat wave, if they
no longer feel like having pizza, then they will
demand fewer slices at every price
◦ Refer to the graphs on page 92
◦ A consumer’s income affects his or her demand for
most goods
◦ Most items we purchase are normal goods, goods
that consumers demand more of when their
incomes increase
◦ An increase in income can cause individuals to
show a greater demand for pizza at every slice
◦ This would produce a curve to the right or an
increase in demand
◦ Inferior goods are goods that you would buy in
smaller quantities, or not at all, if your income were
to rise and you could afford something better
Consumer Expectations
◦ Our expectations about the future can affect our
demand for certain goods
◦ Expecting a higher price in the future, your more
likely going to buy the product today
 Caused immediate demand increase
◦ If your told the product will go on sale next week,
your demand will fall to zero
◦ The current demand for a good is positively related
to its expected future price
 If prices are expected to rise, demand will rise
◦ Changes in the size of population will affect
demand for most products
 Demand for houses, food, and other goods and
◦ Refer to page 94 WWII example
◦ In the next few decades the market will face rising
demand for the goods and services desired by
senior citizens
◦ Are the statistical characteristics of population,
such as age, race, gender, occupation, and income
◦ Businesses use the data to identify who potential
customers are, where they live, and how likely they
are to purchase a specific product
◦ Also packing, pricing, and advertising
◦ Hispanics and Asians create shifts in demand for
goods and services (growing population).
Customer Tastes and Advertising
◦ Economists can not always explain why some fads
begin, advertising and publicity often play a role
◦ Advertising is a factor that shifts the demand curve
because it plays an important role in many trends
◦ New media and technology led to new trends in
◦ Online advertising
◦ Companies advertise because they believe it will
increase demand
The demand curve for one good can also shift
in response to change in the demand for
another good
◦ Complements are two goods that are bought and
used together
 Example skis and ski boots
◦ Substitutes are goods that are used in place of one
 Example is snowboards
Economists describe the way that consumers
respond to price change as elasticity of
◦ Measures how drastically buyers will cut back or
increase their demand for a good when prices
rise or falls
◦ If you buy the same amount or just a little less of a
good after a large price increase, your demand is
inelastic, or relatively unresponsive to price
◦ If you buy much less of a good after a small price
increase, your demand is elastic, or very responsive
to a price change
Percentage change= original # - new #
Original #
x 100
Elasticity= % change in quantity demand
% change in price
The law of demand implies that the number
will always be negative, but for simplicity
sake, economists drop the negative sign
Refer to example on page 98
The elasticity of demand for a good varies at
every price
◦ The demand for a good at one price may be elastic,
and inelastic at a different price
The terms inelastic and elastic have precise
mathematical definitions
◦ If the elasticity of demand for a good is less than 1,
the demand is inelastic
◦ If the elasticity is greater than 1, the demand is
◦ If elasticity is equal to 1, then it is unitary elastic
◦ Refer to page 99
Availability of Substitutes
◦ If there are only a few substitutes for a good, then
even when its price rises, you still buy it
◦ A concert, and life-saving medicines are examples
of inelastic demand
◦ A wide choice of substitutes will make demand
◦ Apples are an example of an elastic demand
Relative Importance
◦ Second factor in determining a good’s elasticity of
demand is how much of your budget you spend on
the good
◦ The higher the jump in price, the more you will
have to adjust your purchases
◦ If you spend half your income on clothes, a
moderate increase will cause a reduction in quantity
or demand become elastic
◦ if shoe laces doubled in price, you probably still
purchase the good and the demand is inelastic
Necessities Versus Luxuries
◦ Whether a person considers a good to be a
necessity or luxury has a great impact on a person’s
elasticity of demand
◦ A necessity a good people will always buy, even
when prices increase
◦ If milk prices rise from $3.49 to $5.49, most
parents will still by it to keep their children healthy
◦ If steak prices increases then people may reduce
the amount of steak bought or skip it altogether
Changes Over Time
◦ When prices change, consumers often need time to
change the spending habits and find substitutes
◦ Because consumers can’t respond quickly, their
demand is inelastic for the short term
◦ Refer to page 102
Elasticity of demand determines how a
change in prices will affect a firm’s revenue,
or income
Computing a Firm’s Total Revenue
◦ Total revenue is defined as the amount of money
the company receives by selling its goods
◦ Determine by two factors: the price of the goods
and the quantity sold
150 slices of pizza x $4.00 per slice = $600
Total Revenue and Elastic Demand
◦ When a good has an elastic demand, raising the
price of each unit by 20% will decrease the quantity
sold by a larger percentage, maybe 50%
◦ This will reduce the firm’s revenue
◦ The same will happen if the price decreases and
quantities increase causing revenue to rise
Total Revenue and Inelastic Demand
◦ When demand is inelastic, prices and total revenue
move in the same direction
◦ Refer to page 103