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Consumer Demand
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Patterns of Consumption
• 70% of household budgets is spent on
housing, transportation and food.
• “Essential” items have changed from
years ago.
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How the Consumer Dollar
Is Spent
Other goods and services
11.0
Entertainment
5.4
Housing
(shelter,
furnishings,
upkeep)
36.4
Medical care
6.1
Clothing
4.9
Food
14.9
Transportation
21.3
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Determinants of Demand
• What determines what we buy?
– The sociopsychiatric explanation
– The economic explanation
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The Sociopsychiatric Explanation
• The desire for goods and services
arises from our needs for social
acceptance, security, and ego
gratification.
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The Sociopsychiatric Explanation
• “Keeping up with the Joneses”
• Self preservation
• Expressions of affluence
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Affluent Teenagers
84%
81%
77%
Television
Stereo
Computer
Video game system
DVD player
CD burner
Cell phone
Auto
In-line skates
Digital Camera
Pager/beeper
64%
61%
49%
47%
37%
34%
27%
9%
0
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10
20 30 40 50 60 70 80
Percent of Teens Owning Item
90 100
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The Economic Explanation
• Demand – The ability and willingness to
buy specific quantities of a good at
alternative prices in a given time period,
ceteris paribus.
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Determinants of Market Demand
• Tastes — desire for this and other
goods
– If a study says ice cream is good for you,
the demand for ice cream would increase.
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Determinants of Market Demand
• Income (of the consumer)
– If you won the lottery you might buy more
ice cream.
– The demand for ice cream would increase,
shifting the demand curve to the right.
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Determinants of Market Demand
• Expectations (for income, prices, tastes)
– If you knew you were going to get rich
soon you might deplete savings to buy
more ice cream now.
– Increases the demand for ice cream.
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Determinants of Market Demand
• Other goods (their availability and
prices)
– If the price of chocolate candy bars
increased, you might buy ice cream
instead of a candy bar.
– Increases the demand for ice cream.
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Determinants of Market Demand
• The number of consumers in the
market.
– If the number of buyers in the ice cream
market increased, the demand for ice
cream would also increase.
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Market Demand
• The total quantities of a good or service
people are willing and able to buy at
alternative prices in a given time period.
• Market demand is the sum of individual
demands.
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Utility Theory
• Economists assume that the more
pleasure a product gives, the higher
price buyers are willing to pay.
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Utility Theory
• Students who like butter are willing to
pay more for buttered popcorn than
non-buttered popcorn because it offers
more total utility.
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Total vs. Marginal Utility
• Utility is the pleasure or satisfaction
obtained from good or service.
• Total utility is the amount of
satisfaction obtained from entire
consumption of a product.
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Total vs. Marginal Utility
• Marginal utility is the change in total
utility obtained by consuming one
additional (marginal) unit of a good or
service.
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Total vs. Marginal Utility
• Marginal utility is the change in total
utility obtained by consuming one
additional (marginal) unit of a good or
service.
change in total utility
Marginal utility =
change in quantity
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Law of Diminishing Marginal
Utility
• The marginal utility of a good declines
as more of it is consumed in a given
time period.
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Law of Diminishing Marginal
Utility
• A student who enjoys popcorn can eat
all he wants for free.
– The first box consumed is rewarding.
– The second box good.
– A third box decent, etc.
– After eating a sixth box, he gets sick.
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Law of Diminishing Marginal
Utility
• Did the sixth box increase his
satisfaction?
• No, it had a negative marginal utility.
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Law of Diminishing Marginal
Utility
• As long as the marginal utility is
positive, the consumer receives
additional satisfaction and total utility
increases.
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Law of Diminishing Marginal
Utility
• Additional quantities of a good yield
increasingly smaller increments of
satisfaction.
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Total vs. Marginal Utility
Marginal utility
Decline
in total
utility
Rising total utility
0
1
2
3
4
5
6
0
QUANTITY OF POPCORN
McGraw-Hill/Irwin
MARGINAL UTILITY
(utility per box)
TOTAL UTILITY (utility per show)
Total utility
Diminishing
marginal utility
Negative
marginal
utility
1
2
3
4 5
6
QUANTITY OF POPCORN
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Utility Theory
• An absolute measure of utility is not
possible because the perception of
satisfaction differs among individuals.
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Utility Theory
• Diminishing marginal utility is a common
experience.
• It is a sufficient basis for economic
predictions of consumer behavior.
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Utility Theory
• Why do we waste water even though it
is vital to human life?
– We consume so much water that additional
water offers little (if any) marginal utility.
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Price and Quantity
• Many forces determine how much we
are willing to buy.
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Price and Quantity
• Economists focus on the relationship
between price and quantity rather than
trying to explain all the forces at once.
– This is the ceteris paribus assumption.
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Law of Demand
• The concepts of marginal utility and
ceteris paribus explain the downward
slope of the demand curve.
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Law of Demand
• With given income, taste, expectations,
and prices of other goods and services,
people are willing to buy additional
quantities of a good only if its price falls.
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Law of Demand
• The higher the marginal utility, the more
you are willing to pay.
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Law of Demand
• Diminishing marginal utility explains why
price must decrease in order for you to
continue to buy a good or service.
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Law of Demand
• According to the law of demand, the
quantity of a good demanded in a given
time period increases as its price falls,
ceteris paribus.
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Demand Schedule
Price
0.50
0.45
0.40
0.35
0.30
Quantity
Demanded
1
2
4
6
9
Price
0.25
0.20
0.15
0.10
0.05
Quantity
Demanded
12
16
20
25
30
0.05
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Demand Curve
• The quantities of a good a consumer is
willing and able to buy at alternative
prices in a given time period, ceteris
paribus.
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PRICE (per ounce)
Demand Curve
$0.55
0.50
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0
McGraw-Hill/Irwin
A
B
As marginal utility declines, so
does the willingness to pay
C
D
E
F
G
H
I
J
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
QUANTITY DEMANDED (ounces per show)
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Price Elasticity
• The response of consumers to a
change in price is measured by the
price elasticity of demand.
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Price Elasticity
• The price elasticity of demand is the
percentage change in quantity
demanded divided by the percentage
change in price.
percentage change in
quantity demanded
Price elasticity (E) =
percentage change
in price
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Price Elasticity
• The price of popcorn goes up 20% and
the quantity demanded goes down 10%.
• The elasticity is:
percentage change in
quantity demanded
–10%
(E) =
=
= – 0.5
percentage change
20%
in price
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Elastic vs. Inelastic Demand
• Demand can be elastic, inelastic, or
unitary elastic.
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Elastic Demand
• Demand is elastic if the absolute value
of E is greater than 1.
• Consumer response is large relative to
change in price.
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Inelastic Demand
• Demand is inelastic if the absolute value
of E is less than 1.
• Consumers are not very responsive to
price changes.
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Unitary Elastic Demand
• Demand is unitary elastic if the absolute
value of E equals 1.
• The percentage change in quantity
demanded is equal to the percentage
change in price.
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Elasticity Estimates
Elastic
Unitary
Inelastic
Estimate
Estimate
Estimate
Airline travel 2.4
Private
1.1
Cigarettes
0.4
(long run)
education
Fresh fish
2.2
Radios and
1.2
Coffee
0.3
television
New cars 1.2-1.5 Shoes
0.9
Gasoline
0.2
(short run)
(short run)
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Elasticity Estimates
• Products that have elastic demands are
airline travel, fresh fish and new cars.
• Products that have inelastic demand are
cigarettes, gasoline and coffee.
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Price Elasticity and Total
Revenue
• Price elasticity explains why producers
cannot charge the highest possible
price.
• Higher prices may actually lower total
sales revenue.
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Price Elasticity and Total
Revenue
• Total revenue — the price of a product
multiplied by the quantity sold in a given
time period.
Total revenue = price X quantity sold
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Elasticity and Total Revenue
Price
$0.50
0.45
0.40
0.35
0.30
Quantity
Total
Demanded Revenue
1
$0.50
2
0.90
4
1.60
6
2.10
8
2.40
Price
$0.25
0.20
0.15
0.10
0.05
Quantity
Total
Demanded Revenue
12
$3.00
16
3.20
20
3.00
25
2.50
30
1.50
1
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PRICE (per ounce)
Elasticity and Total Revenue
$0.55
0.50
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0
McGraw-Hill/Irwin
F
Price cuts increase
total revenue if E>1.
Price cuts decrease
total revenue if E<1.
G
H
Total revenue
Total
revenue = $3.00
Total
= revenue
$3.00 = $3.20
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
QUANTITY DEMANDED (ounces per show)
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Elasticity and Total Revenue
• Price cuts reduce total revenue if
demand is price inelastic.
• Price cuts increase total revenue if
demand is price elastic.
• Price cuts do not change total revenue if
demand is unitary elastic.
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Determinants of Elasticity
• Differences in price elasticity are
explained by several factors:
– Necessities vs. luxuries
– Availability of substitutes
– Relative price
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Necessities vs. Luxuries
• Some goods are so critical to our
everyday life that we regard them as
necessities.
• Demand for necessities is relatively
inelastic.
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Necessities vs. Luxuries
• A luxury good is something we’d like to
have but aren’t likely to buy unless our
income jumps or the price declines
sharply.
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Availability of Substitutes
• The greater the availability of
substitutes, the higher the price
elasticity of demand.
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Relative Price
• Elasticity increases as the price of the
product increases relative to the
consumer’s income.
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Caveat Emptor: The Role of
Advertising
• Advertising campaigns are often
designed to exploit our senses and lack
of knowledge.
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Are Wants Created?
• Advertising is not the only reason
consumption has increased.
• Personality and social interaction
dynamics have changed how much we
consume.
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Are Wants Created?
• A successful advertising campaign is
one that shifts the demand curve to the
right.
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PRICE (dollars per unit)
The Impact of Advertising on a
Demand Curve
Demand curve
after advertising
Demand curve
before advertising
0
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QUANTITY DEMANDED (units per time period)
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Consumer Demand
End of Chapter 4
McGraw-Hill/Irwin
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