Download Demand Curve Basics

Demand Curve Basics
Unit 6: Consumers and Demand
I. Demand
demand – the amount of a good that people are willing and
able to purchase at every possible price
• economists differentiate between demand and quantity
demanded
quantity demanded – the amount of a good that people are
willing and able to purchase at a specific price
Example: white wine
• either way it is expressed, it is a relationship between two
variables, price (P) and quantity (Q):
– price is the independent variable
– quantity is the dependent variable
II. Law of Demand
law of demand – the quantity demanded of a good increases
as price falls and decreases as price rises
• there is an inverse relationship between price and quantity:
Price↓, Quantity↑
Price↑, Quantity↓
• for the law of demand to be true, the following
assumptions are made:
1.
2.
3.
4.
good must be well defined
must be willingness and ability to purchase
particular time period must be specified
only price can change, everything else must be held constant
III. Demand Schedule
demand schedule – a table, chart, or list of the
prices and corresponding quantities demanded
for a good
Your Demand Schedule for Pizza
Combination
Price per Slice
Quantity
Demanded per Day
(# of Slices)
A
$3
1
B
$2
2
C
$1
3
IV. Demand Curve
demand curve – a graph of the prices and corresponding quantities
demanded for a good
• demand curves have the following characteristics:
1.
2.
3.
price (P) always measure on y-axis
quantity (Q) always measured on x-axis
slope always negative:
𝑟𝑖𝑠𝑒
𝑟𝑢𝑛
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑦
𝑠𝑙𝑜𝑝𝑒 =
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑥
𝑠𝑙𝑜𝑝𝑒 =
𝑠𝑙𝑜𝑝𝑒 =
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
∆𝑝
𝑚=
∆𝑞
• going from left to right along a demand curve, the numerator (Δp) is
always negative and the denominator (Δq) is always positive, which
means the slope (m) is always negative
• inverse relationships always have a negative slope when graphed
Your Demand Curve for Pizza
5
Price per Slice
4
3
A
2
B
1
C
Your Demand
0
0
1
2
3
Quantity Demanded per Day (# of Slices)
4
5
V. Individual Demand vs. Market
Demand
market demand – the sum of every consumer’s
demand
Market Demand Schedule for Pizza
My Quantity
Demanded
per Day (# of
Slices)
Market
Quantity
Demanded
per Day (# of
Slices)
Combination
Price per Slice
Your Quantity
Demanded
per Day (# of
Slices)
A
$3
1
.5
1.5
B
$2
2
1
3
C
$1
3
1.5
4.5
• note that each individual can have a different
demand for the same good
Market Demand Curve for Pizza
5
Price per Slice
4
3
Your Demand
My Demand
2
Market Demand
1
0
0
1
2
3
Quantity Demanded per Day (# of Slices)
4
5
VI. Changes in Quantity Demanded vs.
Changes in Demand
• if price is the only variable that changes, then we
say there is a change in the quantity demanded
and there will be movement along the demand
curve
• as price falls from $2 to $1, then the quantity
demanded increases from 2 to 3 and there is
movement down the demand curve (B ↘ C)
• as price rises from $2 to $3, then the quantity
demanded decreases from 2 to 1 and there is
movement up the demand curve (A ↖ B)
Movement along the Demand Curve
5
Price per Slice
4
3
A
2
Your Demand
B
1
C
0
0
1
2
3
Quantity Demanded per Day (# of Slices)
4
5
• if price remains constant, but other variables that
affect demand change, then we say there is a change in
demand and there will be a shift of the demand curve
• there will be a change in the quantity demanded at
every possible price
• as income rises, then the quantity demanded increases
at every possible price and the demand curve shifts
rightward (Original Demand → Demand with Higher
Income)
• as income falls, then the quantity demanded decreases
at every possible price and the demand curve shifts
leftward (Demand with Lower Income ← Original
Demand)
Shifts of the Demand Curve
5
Price per Slice
4
3
Original Demand
Demand with Higher Income
2
Demand with Lower Income
1
0
0
1
2
3
Quantity Demanded per Day (# of Slices)
4
5
VII. Determinants of Demand
• other factors that affect demand besides price
are known as determinants of demand:
1. income
• relationship between income and demand depends on type
of good:
– direct relationship between income and demand for normal
goods (NG):
Income ↑, DemandNG ↑, Shift →
Income ↓, DemandNG ↓, Shift ←
Example:
– inverse relationship between income and demand for inferior
goods (IG):
Income ↑, DemandIG ↓, Shift ←
Income ↓, DemandIG ↑, Shift →
Example:
2. tastes
• demand obviously depends on tastes for that and other
goods
3. prices of related goods
• relationship between price of related goods and demand
depends on type of goods:
– direct relationship between price of substitute goods (SG) and
demand for original good (OG):
PriceSG ↑, DemandOG ↑, Shift →
PriceSG ↓, DemandOG ↓, Shift ←
Example:
– inverse relationship between price of complimentary goods (CG)
and demand for original good (OG):
PriceCG ↑, DemandOG ↓, Shift ←
PriceCG ↓, DemandOG ↑, Shift →
Example:
4. expectations
• expectations about future events, such as price of good
and income affect demand today
5. number of buyers
•
direct relationship between number of buyers and
market demand for a good
Number of Buyers ↑, Market Demand ↑
Number of Buyers ↓, Market Demand ↓
The Downward (Negative) Slope
of the Demand Curve
Unit 6: Consumers and Demand
I. Goal of Consumers
• goal of consumers in an economy is to
maximize utility
utility – satisfaction
• theoretically measured in units called utils
II. Marginal vs. Total Utility
total utility – the cumulative utility from consuming a set number of units of good
vs.
marginal utility – the incremental utility from the consumption of each individual unit
of a good
𝑡𝑜𝑡𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 = 𝑠𝑢𝑚 𝑜𝑓 𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦
𝑡𝑢 =
𝑚𝑢
vs.
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑜𝑡𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑡𝑢2 − 𝑡𝑢1
𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 =
𝑞2 − 𝑞1
𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 =
∆𝑡𝑢
𝑚𝑢 =
1
𝑚𝑢 = ∆𝑡𝑢
III. Man vs. Food Utility
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
-10
Total Utility
Utils
Utils
Marginal Utility
50
45
40
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
-45
-50
IV. Law of Diminishing Marginal Utility
law of diminishing marginal utility – the
marginal utility of a product declines as more
of it is consumed in a given time period
• law holds true for most products
V. Relationship between Marginal and
Total Utility
• as long as marginal utility is positive, your total utility
will increase
• as long as you are getting utility from consuming each
incremental unit of a good, total utility will
increase…but at a decreasing rate, because you will be
getting less and less utility per unit as you consume
more and more units
• eventually you will reach a point where it literally hurts
you to consume another unit and you will experience
negative marginal utility
• this will cause your total utility to begin to decrease…it
will take away from the utility you have already
experienced
• consumers want to consume at maximum total utility
VI. Marginal Utility and Shape of
Demand Curve
Your Demand Curve for
Pizza
Price per Slice
5
4
3
2
1
0
A
B
C
Yo…
0
1
2
3
4
5
Quantity Demanded per Day (#
of Slices)
• Consume 1st Slice:
– TU = $3
– MU = $3
• Consume 2nd Slice:
– TU = $4
– MU = $1
– We will “demand” to only pay
$2/slice if you want us to
consume both slices (the
average of both marginal
utilities)
• Consume 3rd Slice
– TU = $3
– MU = -$1
– We will demand to only pay
$1/slice if you want us to
consume all 3 slices (the
average of all 3 marginal
utilities)
• law of diminishing marginal utility partially
explains the downward slope of demand
curve
• we demand to pay a lower average price the
more units of a good we consume
Price Elasticity of Demand
Unit 6: Consumers and Demand
I. Background
WE KNOW:
• P↓ Q↑ and P↑ Q↓
WE WANT TO KNOW:
• How much will quantity change given price changes, and how will this
affect total revenue
Total Revenue = Price X Quantity
TR = P X Q
IF:
• Quantity changes in proportion to price, there will be no effect on total
revenue
BUT:
• This rarely happens because of the concept of price elasticity
II. Price Elasticity of Demand Formula
III. Price Elasticity of Demand Example
• The price of pizza drops from $15 to $10 and
the quantity demanded rises from 1 to 2.
What is the price elasticity of pizza?
Q:
What do these numbers mean?
A:
Quantity demanded (numerator) rises 67%
given a 40% drop in price (denominator)
OR
Quantity demanded rises 1.68 times (or
168%) faster than price drops
+ and –’s
• in the numerator and denominator, all the + and –
tell us is whether the quantity and price is rising (+)
or falling (-)
• in the final value for E, all the + and – tell us, is
relationship between the two variables
• with price elasticity, the E will always be – because of
the inverse relationship between price and quantity
• you can leave the negative off the final answer, since
it’s a rate of change, not an absolute number
IV. Types of Elasticities of Demand
E > 1: Elastic Good
• Sensitive to price changes
• 10% drop in price yields a 20% rise in quantity demanded
E < 1: Inelastic Good
• Insensitive to price changes
• 10% drop in price yields a 5% rise in quantity demanded
E = 1: Unitary Elastic Good
• Proportional to price changes
• 10% drop in price yields a 10% rise in quantity demanded
V. Effects of Price Elasticity on Total
Revenue
Elastic Goods (E>1):
P↓ TR↑
P↑ TR↓
Inelastic Goods (E<1):
P↓ TR↓
P↑ TR↑
Unitary Elastic Goods (E=1):
P↓ TR→
P↑ TR→
Factors that Affect Price
Elasticity and Other
Elasticities
Unit 6: Consumers and Demand
I. Determinants of Price Elasticity of
Demand
1.
Availability and Closeness of Substitute
Products
• If substitute products are available, then demand
for the original product tends to be price elastic
• Example: Lincoln MKZ – 10% price increase
yields a 20% decrease in the quantity demanded
• If substitute products are not available, then
demand for the original product tends to be price
inelastic
• Example: Prescription Drugs – 10% price increase
yields a 0% drop in the quantity demanded
2.
Proportion of Income
• If the product costs a large proportion of income,
then demand tends to be elastic
• Example: Houses – 10% price increase in homes
yields a 20% decrease in the quantity demanded
• If the product costs a small proportion of income,
then demand tends to be inelastic
• Example: Bicycle - 10% price increase yields a 5%
decrease in the quantity demanded
3.
Luxuries vs. Necessities
• If a product is a luxury, then demand tends to be
elastic
• Example: Lobster – 10% price increase yields a
20% decrease in the quantity demanded
• If a product is a necessity, then demand tends to
be inelastic
• Example: Insulin – 10% price increase yields a 0%
decrease in the quantity demanded
4.
Short-run vs. Long-run
• In the short-run, demand tends to be inelastic
• In the long-run, demand tends to be elastic
• Example: gasoline prices increase
– Demand will not decrease in the short-run because
consumers cannot immediately buy a more fuel-efficient
car
– Demand may decrease in the long-run because
consumers will have had time to purchase a more fuelefficient car
5.
Definition of the Market
• narrowly defined markets or goods tend to be more
elastic, because close substitutes are available
• ex. market for heinz mustard tends to elastic
• broadly defined markets or goods tend to be more
inelastic, because close substitutes are not
available
• ex. market for food tends to be inelastic
II. Other Elasticities of Demand
• elasticities of demand can be calculated
not only for price, but for any variable that
affects demand
• the dependent variable (%ΔQ) will always
be the numerator, and the independent
variable will always be the denominator
• some common ones:
1.
Income Elasticity of Demand (IE)
– measures how much demand changes given changes in income
– 𝐸=
%Δ𝑄
%∆𝐼
– whether IE of demand is + or – depends on type good:
• IE tends to + for normal goods (direct relationship between I
and Q)
• IE tends to be – for inferior goods (indirect relationship
between I and Q)
– whether elastic or inelastic also depends on type of good:
• necessities tend to be income inelastic (Q < I)
• luxuries tend to be income elastic (Q >I)
2. Cross-price Elasticity of Demand (CPE)
– measure how much demand changes for an
original good given changes in prices of
related goods
– whether CPE is + or - depends on type of
goods:
• CPE tends to be + for substitute goods (direct
relationship between QOG and PSG )
• CPE tends to be – for complimentary goods
(inverse relationship between QOG and PCG)