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DEMAND QUANTITY DEMANDED SHIFTS IN DEMAND ELASTICITY OF DEMAND MICROECONOMICS THE DEMAND STUDY OF THE BEHAVIOR & DECISION MAKING OF SMALL UNITS SUCH AS INDIVIDUALS & FIRMS Demand Demand = desire, ability and willingness to own something. The law of demand = when a good’s price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it. THE LAW OF DEMAND As the price of a good or service rises, the quantity that is demanded falls and vice versa, assuming ceteris paribus. Ceteris paribus In the law of demand, we do not include outside factors beyond price. Demand Schedule – table showing combinations of price and quantity demanded of a good or service. The Demand Curve A demand curve is a graphical representation of a demand schedule. The demand curve is downward sloping showing the inverse relationship between price (on the y-axis) and quantity demanded (on the x-axis) When reading a demand curve, assume all outside factors, such as income, are held constant. (This is called ceteris paribus) Market Demand – the sum of all demand in a market – demand for Dominos versus demand for ALL pizza makers… Let’s draw a new demand curve for milk… 7 GRAPHING DEMAND Demand Schedule Price Quantity Demanded $5 10 $4 20 Price of Milk DID THE DEMAND CURVE YOU DREW FOR PIZZA LOOK LIKE THIS? $5 4 3 2 $3 30 $2 50 $1 80 1 10 20 30 40 50 60 8 Quantity of Milk 70 80 Q 3 BEHAVIOR PATTERNS THAT AFFECT THE LAW OF DEMAND THE SUBSTITUTION EFFECT THE LAW OF DIMINISHING MARGINAL UTILITY THE INCOME EFFECT Why does the Law of Demand occur? The law of demand is the result of three separate behavior patterns that overlap: The Substitution effect 2.The Income effect 3.The Law of Diminishing Marginal Utility 1. We will define and explain each… 10 Why does the Law of Demand occur? 1. The Substitution Effect If the price goes up for a product, consumer buy less of that product and more of another substitute product (and vice versa) 2. The Income Effect If the price goes down for a product, the purchasing power increases for consumers -allowing them to purchase more. Why does the Law of Demand occur? 3. Law of Diminishing Marginal Utility Utility = Satisfaction We buy goods because we get utility from them The law of diminishing marginal utility states that as you consume anything, the additional satisfaction that you will receive will eventually start to decrease In other words, the more you buy of ANY GOOD the less satisfaction you get from each new unit consumed. Change in Quantity Demanded A change in the quantity of the product purchased in response to a change in price – CHANGE IN QUANTITY demanded – DEMAND CURVE DOES NOT SHIFT Movement along the demand curve is a change in QUANTITY DEMANDED. ONLY PRICE changes. BREAK – BE A PIRATE PRICE DOESN’T SHIFT THE CURVE….AARGH In your BEST pirate voice please Change in Demand A change in the quantity of the product purchased at all possible prices - DEMAND CURVE SHIFTS Shifts in Demand Ceteris paribus-“all other things held constant.” When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts. A shift means that at the same prices, more people are willing and able to purchase that good. This is a change in demand, not a change in quantity demanded 17 PRICE DOESN’T SHIFT THE CURVE Determinants of Demand B - Change in Number of Buyers R- Change in Price of Related Goods (complements and substitutes) I - Change in the Consumer Income T – Change in Consumer Tastes and Preferences E- Change in consumers’ price expectations TERMS NORMAL GOODS – good that consumers demand more of when their incomes increase - Steak, new cars INFERIOR GOODS – good that consumers demand less of when their incomes increase – great value, ramen COMPLEMENTS – goods that are bought and sold together – peanut butter and jelly – price of peanut butter goes up…demand for jelly goes DOWN. SUBSTITUTES – goods that are used in place of another – hamburger or hot dog – price of hamburger goes up…… demand for hot dogs goes UP. Shifts in Demand 4.00 3.50 Demand price 3.00 2.50 A 2.00 B 1.50 C 1.00 D E 0.50 F D1 0.00 10 20 30 40 50 60 D2 70 Quantity of pecans per day 80 DEMAND SHIFT SHIFT RIGHT-INCREASED DEMAND P SHIFT LEFT-DECREASED DEMAND P S S P2 P1 P1 P2 D Q1 Q2 D2 Q Q2 Q1 D2 D Q DETERMINANTS OF DEMAND-REASONS FOR CHANGES IN DEMAND CHANGES IN INCOME OR WEALTH CHANGES IN NUMBERS OF CONSUMERS CHANGES IN TASTES AND PREFERENCES CHANGES IN THE PRICE OF RELATED GOODS SUBSTITUTES COMPLEMENTS CHANGES IN CONSUMER EXPECTATIONS MEMORY AID – “BRITE” Tastes and Preferences - EX. People prefer the Nike shoe to other brands because it uses newer technology. Demand increases, curve shifts right. Related Goods and Services - Complements and Substitutes – EX. The price of shoe laces quadruples. People start to wear more sandals, demand decreases, curve shifts left Income - EX. NBA gives all players a huge raise, they can now buy more shoes. Demand increases-Curve shifts right Buyers, Number of, and Consumer Information - EX. Sports arena is closed for renovations and all games are moved to a different county. Fewer Sports fans visit the Nike store next to the arena. Fewer buyers demanding goods, Demand decreases-curve shifts left Expectations - EX. People hear that price of Nikes will go up in the future. They stock up now. Demand increases-curve shifts right SUMMARY – DEMAND RELATIONSHIP EQUATION P D Q Demand=consumer=buyer=utility=lower price=higher quantity demanded=Law of Demand=spending=inverse relationship=negative slope=downward curve=revenue curve NOW YOU PRACTICE COMPLETE Activities 1 and 3 on Demand ..\Music\Cupid - Cupid Shuffle (Music Video).mp4 Review – The Law of Demand Consumers will be motivated to buy more goods and services at lower prices than at higher prices. In short hand, as price increases, the quantity demanded decreases. Therefore, there is an inverse relationship between price and quantity demanded on the demand curve in a market. Remember that demand starts with the letter D for Downward-sloping. On the sample demand curve below, you can see how the quantity demanded decreases as the price increases. P D Q Change in Quantity Demanded vs. Change in Demand DEMAND refers to all of the prices and quantities of consumers in the market for a good. A change in the price of a good, service, or factor of production causes “a movement along the demand curve” also known as a “change in quantity demanded”. The price change causes a movement along the demand curve showing a different quantity consumers will purchase at the new price. This is DIFFERENT from a change in demand which SHIFTS the entire curve. Movement along the curve Ceteris paribus The graph below shows a change in quantity demanded and is caused by a price change NOT a determinant of demand Change in Demand Shift in Demand The curve will move left (decrease) or right (increase) This is the result of a change in something (a determinant) OTHER than price. What are the non price determinants? B – number of buyers R – price of related goods (substitutes or complements) I – Income T – tastes and preferences E – buyer expectations The entire demand curve shifts Shift to the left = decrease The entire demand curve shifts Shift to the right = increase ELASTICITY OF DEMAND Key Terms Elasticity of demand: a measure of how consumers respond to price changes Elastic demand: describes demand that is very sensitive to a change in price Inelastic demand: describes demand that is not very sensitive to price changes Consumer Response Elasticity of demand – how consumers respond to price changes; it measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls. Your demand for a good that you will keep buying despite a price change is inelastic. If you buy much less of a good after a small price increase, your demand for that good is elastic. Elastic Demand Comes from one or more of these factors: 1. The availability of substitute goods (S) 2. Percentage of your income that a good or service requires (I) 3. If the good or service is a necessity or a luxury (N) Measuring Elasticity What is the homeowner’s elasticity of demand for gasoline? What factor affected elasticity? Factors Affecting Elasticity Is there a Substitute? If there are a few substitutes for a good, then even when its price rises greatly, you might still buy it. If the lack of substitutes can make demand inelastic, a wide choice of substitute goods can make demand elastic. What percentage of income is the good or service? how much of your budget you spend on a good. Spend alot = Elastic Spend a little = Inelastic Is the good a necessities or a luxury? Is the good necessary for survival? Total Revenue Elasticity is important to the study of economics because elasticity helps us measure how consumers respond to price changes for different products. The elasticity of demand determines how a change in price will affect a firm’s total revenue or income. TOTAL REVENUE THE QUANTITY OF GOODS AND SERVICES THAT A FIRM SELLS MULTIPLIED BY THE PRICE OF EACH G/S. 1000 Birdhouses X $4 = $4000 revenue Increase price = revenue goes up Decrease price = revenue goes down Checkpoint: Why does a firm need to know whether demand for its product is elastic or inelastic? Knowledge of how the elasticity of demand can affect a firm’s total revenues helps the firm make pricing decisions that lead to the greatest revenue. If a firm knows that the demand for its product is inelastic at its current price, it knows that an increase in price will increase total revenue. If a firm knows that the demand for its product is elastic at the current price, it knows that an increase in price would reduce total revenue. WHY? Because there is a substitute…..