Transcript Microeconomics Pt.2: Factors Effecting Demand A) Change in the

Microeconomics
Pt.2:
Factors Effecting
Demand
1.
Companies realize that, over time, consumer demand constantly changes.
Because of this change by consumers, companies have to change too, or they
risk losing profits to competitors that are better at meeting these customer’s
new demands.
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Such changes in consumer and business demands have an effect on both the
demand schedule and the demand curve graph. When it comes to the demand
graphs, there are two very distinct types of changes.
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When the price of a product changes, while all other factors remain the
same, we have a change in the quantity demanded.
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When the price of a product drops, consumers pay less, and a result, have
some extra income to buy more of the item; thus the Quantity increases. If
the price goes up, consumers feel a bit poorer and buy fewer of the items,
thus Quantity decreases.
5.
This is called the Income Effect, which is a change in quantity demanded
because of a change in price because it alters consumer’s real income.
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A lower price also means that an item, like a CD, will be relatively less
expensive than other something else; like concerts and movies. As a result,
consumers will have a tendency to purchase a less costly item than a more
expensive one. This is called Substitution Effect.
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Whenever a price change causes a change in quantity demanded, the change
appears graphically as a movement along the demand curve. The change in
quantity demanded can be either an up or down movement up or down on the
graph line.
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When it comes to goods, sometimes other outside factors change
while the price remains the same.
When this happens, people may decide to buy different amounts of
the product at the same prices. This is known as a Change in
Demand.
As a result of this change, the entire demand curve shifts – to the
right to show an increase in demand, or to the left to show a
decrease in demand.
When demand changes, a new curve must be added to the graph to
reflect the new quantities of an item demanded at different level of
prices by consumers.
Demand of an item can change like this because of changes like:
Consumer income, consumer tastes, the price of related goods,
failed expectations of a good and the number of consumers
changes.
A change in demand can also happen if consumers stop buying one
brand name of an item and instead buy a similar but cheaper
competitive item.
These items are known as Substitutes because they can be used in
place of other more expensive products that consumers usually buy.
This change of the demand curve can also affects the market
demand curve, if there has been a significant change in the number
of consumers purchasing the same item.
C) Elasticity of Demand
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Consumers react to a change in price by changing the quantity that
they demand of an item, although the actual size of a consumers
change in demand can vary; sometimes small and sometimes big.
This consumer change of quantity demanded for an item is known
as Demand Elasticity, which is the extent to which a change in
price causes a significant change in the quantity demanded.
Economists say that demand is Elastic when a given change in
price causes a much larger change in quantity demanded.
To illustrate, look at Figure 1 and how price and quantity demand
changed between points A and B on the demand curve of the graph.
As we move from point A to point B, we see that price declines by
one-third, or from $3 to $2. At the same time, the quantity
demanded doubles from two to one units.
Because the change in quantity demanded is much larger than the
change in price, the actual demand between those two points is
considered to be Elastic.
This type of Elasticity is typical of the demand for products like
green beans, corn, or other fresh garden vegetables. Because prices
of these products are lower in the summer, consumers increase the
amount they purchase during that time.
When prices are considerably higher in the winter, consumers tend
to buy canned or frozen products instead.
Demand Elasticity
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For different types of products, demand may be
Inelastic, which means that a change in the price of
an item may cause a relatively smaller change in the
quantity demanded of that product by consumers.
We can see the case of inelastic demand in Figure 2.
In this case, the one-third drop in price from point A
to B on the graph only causes quantity demanded
to increase by only 25%.
This is typical of the demand for a product like table
salt. A change in the price of salt does not bring
about much change in the quantity purchased by
consumers.
Even if the price of salt was cut in half, the quantity
demanded by consumers would not increase much
because people can consume only so much salt.
Similarly, if the price doubled, we would still expect
consumers to demand about the same amount of
salt, because people only spend such a small portion
of their budget on salt (but is a much wanted item).
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E) The Total Expenditures Test
To estimate elasticity of an item, it is useful to look at the impact of a price change on Total
Expenditures, or the amount that consumers spend on a product at a particular price. This is sometimes
called the Total Expenditures Test.
We can find total expenditures by multiplying the price of a product by the quantity demanded for any
point along the demand curve. To illustrate the total expenditure look at point A on the graph for Figure 1,
which is $6. The $6 is determined by multiplying two units times the price of $3.
Likewise, the total expenditure under point B in Figure 1 is $8, or $2 times four units. By observing the
change in total expenditures when the price changes for a product, we can then test for elasticity.
The Demand Curve in Figure 1 is elastic. When the price drops by $1 per unit, the increase in the quantity
demanded is large enough to raise total expenditures from $6 to $8. The relationship is simple, when the
price goes down, total expenditures go up.
The demand curve in Figure 2 is inelastic. In this case, when the price drops by $1, the increase in the
quantity demanded by consumers is so small that total expenditures fall below $6. This is why the demand
curve is an inelastic demand, because the total expenditures decline when the price declines.
The relationship between the change in price and the change in total expenditures is shown if Figure 3. If
the changes in price and expenditures move in opposite directions, demand is elastic. If they move in the
same direction, demand is inelastic.
While this discussion about elasticity may seem somewhat unnecessary to you, knowledge of demand
elasticity is extremely important to most businesses. What would happen if you sold a product with elastic
demand?
If you raise the price, your total profit – which is the same as consumer expenditures – will go down
instead of up. This outcome is most definitely the exact opposite of what you intended to happen.
This is exactly why some businesses experiment with different prices when they introduce a new product
to the market. They may adjust prices repeatedly to see how customers respond to new prices.
If a business can determine a new product’s demand elasticity, it will be able to find a set price for the new
product that will maximize a very large profit for the company. This is why demand elasticity is more
important to the world of business than most people realize.