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Why the Demand Curve slopes down
One Reason:
Substitution Effect
At a lower price consumers can
switch to the cheaper good,
substituting the cheaper for
the more expensive.
Why the Demand Curves slopes down
A Second Reason:
Income Effect
A lower price of a good will
increase purchasing power
of the consumer. They can
buy more than before.
Why the Demand Curves slopes down
A Third Reason:
Diminishing Utility
Consumers get less satisfaction
as they buy more of a good.
For the consumer to buy more
the price must be reduced.
The Pizza Demand Curve
• The demand for frozen pizzas
reflects the law of diminishing
marginal utility.
• Because marginal utility (MU)
falls with increased consumption,
so does a consumer’s maximum
willingness to pay -- marginal
benefit (MB).
John’s demand curve
for frozen pizza
MB1
$3.50
MB2
$3.00
MB3
Price =$2.50
$2.50
• A consumer will purchase until
MB = Price . . . so at $2.50
they would purchase 3 frozen
pizzas and receive a consumer
surplus shown by the shaded
area (above the price line and
below the demand curve).
MB4 < MB3 < MB2 < MB1
because
MU4 < MU3 < MU2 < MU1
MB4
$2.00
d = MB
1
2
3
4
Frozen pizzas
per week
Marginal Utility per $
Number
Bought
Domestic
$1
MU
Imported
$2
MU
1
10
24
Domestic
MU/$
____
2
8
20
____
____
3
7
18
____
____
4
6
16
____
____
5
5
12
____
____
6
4
6
____
____
7
3
4
____
____
With Constraint
Imported
MU/$
____
Without Income Constraint? With $12?
MUB
MUN
MUA
=
=
.
.
.
=
PB
PN
PA
Choices are based on
Comparisons of MU per $
spent on each good
Which is more valuable water or diamonds?
“Why are you going out? Are
your friends more important to
you than me?”
High Total Value, but Smaller
Marginal Value
Individual and Market Demand Curves
• Consider Jones’s demand for frozen pizza.At $3.50 Jones
demands 1 pizza …
and so on …
at $2.50 3 pizzas …
• Consider Smith’s demand for frozen pizza. At $3.50 Smith
demands 2 pizzas … at $2.50 3 pizzas …
and so on …
• The market demand curve is merely the horizontal sum of the
individual demand curves (here Jones and Smith).
• The market demand curve will slope downward to the right,
just as the individual demand curves do.
Jones
Smith
2-Person market
$3.50
$3.50
$3.50
$2.50
$2.50
$2.50
d
D
d
1 2 3 4 5 6 7 8
1 2 3 4 5 6 7 8
Weekly frozen pizza consumption
1 2 3 4 5 6 7 8
again
the responsiveness of the amount
purchased to a change in price.
% Change in
% Q
Price Elasticity quantity demanded
of demand = % Change in Price = % P
- or put more simply -
=
(Q0 - Q1 )
Q0
( P0 - P1 )
P0
=
(Q0 - Q1 )
Q0
X
P0
( P0 - P1 )
PED > 1 Elastic
< 1 Inelastic
= 1 Unit Elastic
Quan Price Quan Price Ch in Q X P1
1
1
2
2
Q1
Ch in P
___ X ___ = ___
100
5
120
3
20
8
25
7
___
12
3
16
0
___
X
___ = ___
___
X
=
___
150
12
200
10
___
45
6
45
8
___
X
___ = ___
32
24
40
2
___
X
___ = ___
___
___
Quan Price
1 X 8
2
3
4
5
6
7
8
X
X
X
X
X
X
X
7
6
5
4
3
2
1
Total
Revenue
Elasticity
=
___
=
___
=
___
=
___
=
___
=
___
=
___
___
___
___
___
___
___
___
___
Calculate the Price Elasticity of the following:
1. The number of cans demanded of a soft drink
increases by 30 % after its price decreases by 40%
2. The number of available apartments increases by
8% following a 6 % increase in rents
3. The number of Caesar salads demanded at a
restaurant increases from 60 to 80 per week when the
price falls from $5.00 to $4.50
4. At a price of $200, 10,000 treadmills were supplied
each month. Since the price increased to $250, 14,000
are supplied each month.
5. The number of DVDs demanded each weekend from
Blockbuster falls from 500 to 400 following an increase
in the rental charge from $2.00 to $2.40
Mid Points Formula
% Change in
% Q
Price Elasticity quantity demanded
of demand = % Change in Price = % P
- But use average Q and average P -
(Q0 - Q1 )
=
(Q0  Q1 ) 2
( P0 - P1 )
( P0  P1 ) 2
(Q0 - Q1 ) (Q0 Q1 )
=
( P0 - P1 ) ( P0 P1 )
What affects Elasticity???
1. Available Substitutes
2. Necessity vs Luxury
3. Proportion of Income
4. Time to shop around
Different Elasticities
• Perfectly inelastic:
An increase in Price
results in no change in
Quantity
Mythical
demand
curve
(a)
Quantity/
time
• Relatively inelastic:
A percent increase in
Price results in a smaller
% reduction in Quantity
Demand for
Cigarettes
(b)
Quantity/
time
Demand curve of
unitary elasticity
(c)
Quantity/
time
• Unitary elasticity:
The percent change in
quantity demanded due
to an increase in price is
equal to the % change in
price.
Elasticity of Demand
Demand for
Granny Smith
Apples
(d)
• Relatively elastic:
A % increase in Price
leads to a larger %
reduction in Quantity.
Quantity/
time
• Perfectly elastic:
Consumers will buy all of
Farmer Hollings’s wheat at
the market price, but none
will be sold above the
market price.
Demand for Farmer
Hollings’s wheat
(e)
Quantity/
time
Examples
Inelastic
Salt
Matches
Toothpicks
Airline travel (short run)
0.1
0.1
0.1
0.1
Gasoline (short run)
0.2
Gasoline (long run)
Natural gas, home (short run) 0.7
Natural gas, home (long run) 0.1
0.5
Coffee
0.3
Fish (cod), at home
Tobacco products (short run) 0.5
0.5
Legal services (short run)
0.4
Physician
0.6
Taxi (short services
run)
0.6
Automobiles (long run)
0.2
Approximately Unitary Elasticity
Movies
Homes, owner occupied (long run) 0.9
1.2
Shellfish (consumed at home)
0.9
Oysters (consumed at home)
1.1
Private
education
1.1
Tires (short
run
0.9
Tires (long run)
1.2
Radio and television receivers
1.2
Elastic
Restaurant
meals
Foreign travel
(long run)
Airline travel (long run)
Fresh
green peas
Automobiles
(short run
Chevrolet automobiles
Fresh tomatoes
2.3
4.0
2.4
2.8
1.4
4.0
4.6
Income Elasticity
• the responsiveness of a product’s
demand to a change in income.
% Change in
Income Elasticity quantity demanded
of demand = % Change in Income
• A normal good has a positive
income elasticity of demand.
– As income increases, the demand
for normal goods increases.
• Goods with a negative income
elasticity are inferior goods.
– As income expands, the demand
for inferior goods will decline.
Income Elasticity of Demand
Low Income Elasticity
Margarine
Fuel
Electricity
Fish (haddock)
Food
Tobacco
Hospital care
- 0.20
0.38
0.20
0.46
0.51
0.64
0.69
High Income Elasticity
Private education
New Cars
Recreation and amusements
Alcohol
2.46
2.45
1.57
1.54
Cross Price Elasticity
• the responsiveness of a product’s demand
to a change in the price of another good.
Cross Price
Elasticity
=
% Change in
Qx
% Change in Py
• A complement has a negative cross
price elasticity.
– As Py increases, the demand for Y decreases,
and demand for goods that are consumed
with Y also decreases.
• A substitute has a positive cross price
elasticity
– As Py increases, the demand for Y decreases,
and demand for goods that can be consumed
instead of Y also decreases.
1. If sleeping is required for good
health and survival and attending
Economics class is not, why is it more
important to attend class rather than
sleeping in? (The answer may appear
on page 455)