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Ch 4
Free Market
 In a Market System the interaction between buyers and
sellers determine prices of most goods and the quantity of
products produced.
 Demand- the desire to own something and the ability to pay
for it.
 Law of Demand-when price is lower, consumers will buy
more of it. When the price is high, consumers buy less of it.
 Law of Demand is the combination of two patterns of
behavior… Substitution Effect and Income Effect
 Substitution Effect- Consumers reaction to a rise in the
price of one good by consuming less that good and more of a
substituted good.
 Income Effect- When prices rise and our income stays the
same the consumer feels poorer. Therefore, they will not buy
as much of a certain good but not replace it with an
alternative good.
 A Demand for a good means you must be willing and able
to buy it at the specified price
 Demand Schedule-a table that lists the quantity of good
that a person will purchase at each price in the market. See
pg 81. Business owners find the Demand Schedule chart very
helpful.
 Market Demand Schedule- shows quantity demand at
each price by all consumers in the market. For example- it
would allow a restaurant owner to predict the total sales of
pizza at several different prices.
 Demand Curve- Can be used to predict how people will
change their buying habits when the price of a good rises or
falls.
Analysis of Change in Demand
 When only the price of a good is taken into account it is
called ceteris paribus, the Latin phrase for “all other things
held constant” Therefore the Demand Schedule would only
show the change in price as a factor. However, in reality there
are generally multiple factors that cause a change in demand
of a product besides just the price. When the ceteris paribus
rule is dropped and other factors are analyzed the entire
demand curve shifts. When the entire curve shifts it is known
as a change in demand
 Reasons for the shift of the Demand Curve…
Elasticity of Demand
 Elasticity of Demand is the study of the products that will be
bought regardless of price vs products that are consumed
based on price.
 Inelastic-demand for a good that you will keep buying
regardless of price increase.
 Elastic-buying less of a good even if the price increase is
small.
 To compute elasticity of demand, take the percentage change
in demand of a good and divide this number by the
percentage change in the price of the good.
 Elasticity= Percentage change in quantity demanded
Percentage change in price
 Price Range- The elasticity of demand for a good varies at
every price level. Demand for a good can be highly elastic at
one price and inelastic at a different price.
 Ex- price change from .20 cents to .30 cents is easier to take
verses $4.00 to $6.00. Even though both price points increased
at the same rate of 50% -less consumers would purchase the
product at a price increase of $2.00 verses .10 cents
Factors Affecting Elasticity
Demand for some goods are more elastic than others. To
determine what goods are inelastic and what goods are elastic
one must determine what is essential and what is not.
- If there are few substitutions for goods then the
product is less elastic
- Life saving medicine is inelastic
However, if there are ample substitutions for a product then the
product is more elastic
 Another factor of elasticity is how much of your budget is
spent on the product. If you already spent a substantial
portion on a product and the price increases then 1)
something else in your budget would have to take a cut or
2)you would scale back on the product and consume less.
Your decision will determine how elastic the product is
 Necessity vs Luxury Necessity is a good people will always buy (inelastic)
 Luxury is something not necessary and purchases will vary
based on price( elastic)
 Elasticity is important to the study of economics because
elasticity helps us measure how consumers respond to price
changes for different products.
 Total Revenue is the amount of money the company receives
by selling its goods
 The law of demand tells us that an increase in price will
decrease the quantity of demanded. When a good has an
elastic demand, raising the price will decrease the units sold.
For example if price increases 20% the units sold could
decrease as much as 50% or more. This would reduce the
companies total revenue.
 Likewise, if you reduce the price the units sold could increase
However- if the product is inelastic the raise in price will not
change drastically the amount of units sold.
All of this data helps business determine the elasticity or
inelasticity of their product to the consumer