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Chapter 4- Demand
Section 1:
Understanding Demand
 What is the law of demand?
 How do the substitution effect and income
effect influence decisions?
 What is a demand schedule?
 What is a demand curve?
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Ch 4.1
What is Demand?
Demand is the willingness and
the ability to consume a good
or service.
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Ch 4.1
What Is the Law of Demand?
The law of demand - consumers
buy more when price decreases
and less when price increases.
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Ch 4.1
What Is the Law of Demand?
 The law of demand is the result of two separate
behavior patterns, the substitution effect and the
income effect.
 Describes different ways a consumer can change
spending patterns for other goods.
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Ch 4.1
The Substitution Effect and Income
Effect
The Substitution Effect
 The substitution effect occurs when
consumers react to an increase in a good’s
price by consuming less of that good and
more of other goods.
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Ch 4.1
The Substitution Effect and Income
Effect
The Income Effect
 The income effect happens when a person
changes his or her consumption of goods
and services as a result of a change in real
income.
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Ch 4.1
The Demand Schedule
 A demand schedule is a table that lists the
quantity of a good a person will buy at each
different price.
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Ch 4.1
The Demand Schedule
 A market demand schedule is a table that lists the
quantity of a good all consumers in a market will
buy at each different price.
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Ch 4.1
The Demand Curve
 A demand curve is a graphical representation of
a demand schedule.
 When reading a demand curve, assume all
outside factors, such as income, are held
constant (Ceteris paribus)
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Ch 4.1
The Demand Curve
Market Demand Curve
Price per slice (in dollars)
3.00
2.50
2.00
1.50
Demand
1.00
.50
0
0
50
100
150
200
250
300
Slices of pizza per day
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Ch 4.1
350
Section 2:
Shifts of the Demand Curve
 What is the difference between a change in quantity
demanded and a shift in the demand curve?
 What factors can cause shifts in the demand curve?
 How does the change in the price of one good affect
the demand for a related good?
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Ch 4.2
Shifts in Demand
 A demand curve is accurate only as long as the
ceteris paribus assumption is true.
 When assumption is dropped, movement no longer
occurs along the demand curve, the entire demand
curve shifts.
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Ch 4.2
What Causes a Shift in Demand?
 Change in demand:
1. Income
A normal good is a good that
consumers demand more of
when their incomes increase.
Examples???
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Ch 4.2
What Causes a Shift in Demand?
 Change in demand:
An inferior good is a good that
consumers demand less of
when their income increases.
Examples???
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Ch 4.2
What Causes a Shift in Demand?
 Change in demand:
2. Consumer Expectations
Whether or not we expect a good to
increase or decrease in price in the
future greatly affects our demand
for that good today.
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Ch 4.2
What Causes a Shift in Demand?
 Change in demand:
3. Population
Changes in the size of the
population also affects the
demand for most products.
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Ch 4.2
What Causes a Shift in Demand?
 Change in demand:
4. Consumer Tastes and Advertising
Advertising plays an important
role in many trends and therefore
influences demand.
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Ch 4.2
What Causes a Shift in Demand?
Review
Name some factors that cause
changes in demand.
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Ch 4.2
Prices of Related Goods
The demand curve for one good can be
affected by a change in the demand for
another good.
 Complements are two goods that are bought and used
together.
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Ch 4.2
Prices of Related Goods
 Substitutes are goods used in place of one another.
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Ch 4.2
Section 3:
Elasticity of Demand
 What is elasticity of demand?
 How can a demand schedule and demand curve be
used to determine elasticity of demand?
 What factors affect elasticity?
 How do firms use elasticity and revenue to make
decisions?
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Ch 4.3
What Is Elasticity of Demand?
Elasticity of demand is a measure
of how consumers react to a
change in price.
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Ch 4.3
What Is Elasticity of Demand?
 Demand for a good that consumers will continue to buy despite a price
increase is inelastic.
 Inelastic demand is like bubble gum and you can stretch and stretch but no
matter what the price is, people will pay it
 Demand for a good that is very sensitive to changes in price is elastic.
 elastic demand is like a rubber band where if you stretch the price too much,
people will stop buying and it snaps back
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Ch 4.3
Calculating Elasticity
Elasticity is determined using the
following formula:
Elasticity =
% change =
% change in quantity demanded
% change in price
Original no. – New no.
Original number
x 100
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Ch 4.3
Elastic Demand
Elastic Demand
If demand is elastic, a small change in
price leads to a relatively large change in
the quantity demanded. Follow this
demand curve from left to right.
$7
The price decreases from $4 to $3, a
decrease of 25 percent.
Pri
ce
$6
$5
Demand
$4
$3
$2
26
$1
0
5 10 15 20 25 30
Quantit
y
The quantity demanded increases
from 10 to 20. This is an increase of
100 percent.
Elasticity of demand is equal to 4.0.
Elasticity is greater than 1, so demand
is elastic. In this example, a small
decrease in price caused a large
increase in the quantity demanded.
$4 – $3
x 100 = 25
$4
10 – 20
x 100 = 100
10
100%
= 4.0
25%
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Ch 4.3
Inelastic Demand
Inelastic Demand
$6
If demand is inelastic, consumers are not very
responsive to changes in price. A decrease in price
will lead to only a small change in quantity
demanded, or perhaps no change at all. Follow this
demand curve from left to right as the price
decreases sharply from $6 to $2.
The price decreases from $6 to $2, a decrease of
about 67 percent.
$5
The quantity demanded increases from 10
to 15, an increase of 50 percent.
Price
$7
Demand
$4
$3
$2
27
$1
0
Elasticity of demand is about 0.75. The
elasticity is less than 1, so demand for this
good is inelastic. The increase in quantity
demanded is small compared to the
decrease in price.
$6 – $2
x 100 = 67
$6
10 – 15
x 100 = 50
10
50%
= 0.75
67%
5 10 15 20 25 30
Quantity
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Ch 4.3
Factors Affecting Elasticity
 Factors that affect the elasticity of demand
1. Availability of Substitutes
If there are few substitutes for a good, then
demand will not likely decrease as price
increases. The opposite is also usually true.
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Ch 4.3
Factors Affecting Elasticity
 Factors that affect the elasticity of demand
2. Relative Importance
How much of your budget you spend on
the good?
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Ch 4.3
Factors Affecting Elasticity
 Factors that affect the elasticity of demand
3. Necessities versus Luxuries
Whether a person considers a good
to be a necessity or a luxury has a
great impact on the good’s elasticity
of demand for that person.
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Ch 4.3
Factors Affecting Elasticity
 Factors that affect the elasticity of demand
4. Change over Time
Demand sometimes becomes more
elastic over time because people
can eventually find substitutes.
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Ch 4.3
Elasticity and Revenue
The elasticity of demand determines
how a change in prices will affect a
firm’s total revenue or income.
 A company’s total revenue is the total amount of
money the company receives from selling its
goods or services.
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Ch 4.3
Elasticity and Revenue
 Firms need to be aware of the elasticity of
demand for the good or service they are
providing.
 If a good has an elastic demand, raising prices
may actually decrease the firm’s total revenue.
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Ch 4.3