Download demand - UTA Economics

Lecture 2
The Law of Demand
■ Our objectives:
► Explain individual choices among unlimited wants in the face
of limited resources
► Develop a theory that satisfies the universal criteria for
theories
► Apply the theory to what we observe around us
The Law of Demand
■ Holding all other relevant factors constant, the
lower the price of a good, the greater will be the
quantity demanded.
► Like all scientific propositions, it is a ceteris paribus (“other
things equal’) statement
► It is symmetric: a higher price leads to a smaller quantity
demanded
► Note the terminology:
-changes in the price of the good lead to changes in “quantity
demanded” ---- they DO NOT lead to changes in demand
Why focus on the Law of Demand?
► This is the most powerful proposition in economics.
► Sprinkler design in arid and wet climates
► Building heights in cities compared to small towns
► The seasonal pattern of fruit and vegetable prices
► Why people sit in inferior seats to watch games or performances
► The shape of waterfront properties
► Electricity prices and automatic switches
► Etc., etc., etc.
Foundations
■ The principle of Diminishing Marginal Value
► As the rate of consumption rises, the marginal use value of
the next unit declines
■ Decision Rule
► Chose a rate of consumption so that marginal use value of the
last unit equals price:
MV=P
■ When combined, these yield the Law of Demand
Diminishing Marginal
Value
Rate of Consumption
1
2
3
4
5
Marginal Value
2.00
1.75
1.10
0.50
0.25
Diminishing Marginal
Value
MV
Units/time period
Adding the Decision Rule MV=P
yields a Demand Curve (D)
PRICE
Demand
UNITS/TIME PERIOD
The Demand Function
Summarizes the relationship between quantity consumed and the
factors determining that quantity
■ Price of the good in question—determines the location along
the demand curve
■ Other factors — determine the placement of the demand curve:
►
►
►
►
►
Prices of related goods
Income of the buyer
Tastes (preferences) of the buyer
Expectations held by the buyer, regarding the future
Other matters, particular to each good, including quality, etc.
The Role of Tastes
De gustibus non est disputandum
■ They are unmeasurable, and so we ignore them
■ Look to marketing and psychology for guidance
here, for you’ll not get any from economists!
■ For us, tastes are the unexplained portion of
consumption
Expectations
■ Difficult to measure under most
circumstances
■ When measurable, include in the analysis
■ Like tastes, these can be used to “explain”
anything
► Don’t fall into this trap
The Demand Function
■ The rate of consumption of a good is a function of:
► The “own” price of the good
------------------------------------► The ceteris paribus conditions:
- Prices of related goods
- Income
- Other, idiosyncratic factors (the “X-vector”)
Demand for DVD Rentals
Price $
Monthly consumption at different income levels
$1000/mo
$2000/mo
$3000/mo
6
1
2
5
5
3
2
1
2
4
5
6
4
8
10
12
7
11
13
15
Demand for DVD Rentals
PRICE
Changes in Demand
QUANTITY
Related Goods
■
Substitutes:
► Intuitively, goods used in place of each other
► Different brands of gasoline;
theater v. movie rentals;
DVDs v. concert tickets
■
Complements:
► Intuitively, goods used together
► Computer hardware and software;
tennis balls and rackets;
airplane travel and hotel rooms
Changes in the Price of Related Goods
These effects define the relationship “substitute”
■ X and Y are substitutes if and only if:
► A change in price of X changes demand for Y in same direction
- Px up implies Dy up (Dy shifts to the right)
- Px down implies Dy down (Dy shifts to the left)
► Effect of Py on Dx is also in same direction
More on the Prices of Related Goods
These effects define the relationship “complement”
■ V and W are complements if:
► A change in price of V changes demand for W in
opposite direction
- Pv up implies Dw down (Dw shifts to left)
- Pv down implies Dw (Dw shifts to right)
► Effect of Pw on Dw is also in opposite direction
Changes in Income
■ Normal Goods:
► Change in income changes demand in same direction
- Higher income causes increase in demand
- Lower income causes decrease in demand
► ”Superior” good is a variant: change in demand due to income
change is quite large
■ Inferior goods:
► Change in income changes demand in opposite direction
- Higher income causes decrease in demand
- Lower income causes increase in demand
Increase in Demand
Price
■Caused by:
-Higher price of substitute
-Lower price of complement
-Increase in income if superior
-Decrease in income if inferior
D higher
D lower
Decreases in Demand
PRICE
Caused by:
-Lower price of substitute
-Higher price of complement
-Decrease in income if superior
-Increase in income if inferior
D low
D high
Quantity
Terminology
This is important to avoid confusion
■ Changes in quantity demanded:
► Caused by changes in own price of good
► Refer to movement along a given demand curve
■ Changes in demand:
► Caused by changes in ceteris paribus conditions
- Prices of other goods
- Income
- Other factors
► Refer to a shift of the entire demand curve
■ Be precise and you’ll be richer. . . .
What else would you want to know?
The Demand curve plots the relationship between
price and quantity demanded – nothing else –
everything else is ceteris paribus.
What else would you want to know if you wanted to
understand that market better?
Name likely relevant factors:
Deriving a Real Demand Curve
Define your market:
Boulder, Colorado, over time;
consumption of water by people
served by city water; price per
1,000 gallons; billions gallons/yr.
consumed by demanders.
Year
1968
1972
1977
1982
Price
$0.28
$0.36
$0.50
$0.74
Quantity
29
19
13
9
Price
Quantity
Questions on Law of Demand
True – False
1.
Your mother gives you a coat that cost her $100
and that she likes, but you hate. You have
received a gift worth $100.
2.
In thinking about demand by consumers, we
usually assume that income varies among
consumers but that prices do not.
3.
If the price of mailing a letter rises by 10 cents,
from 30 cents to 40 cents; and the price of
sending a letter by special delivery increases 10
cents, from $3.20 to $3.30, consumers will
purchase the same proportions of both kinds of
delivery services.
Which Goods Are Complements,
Which Are Substitutes?
1.
2.
3.
4.
5.
6.
Plate glass and bricks.
Steel and bricks.
Wine and beer.
Domestic shirts and imported shirts.
Oil from Iran and coal from China.
Paper and pencils.
Needs and Wants

When you truly need something, such
as a new television, your demand
curve is a vertical line. That is, you do
not care what price you have to pay
because you really need it? What
about the need to eat dinner? The
need to obtain an MBA? The need to
have an operation because you have
cancer?
Demand Application
In the past 20 years in the U.S., the
price of attending college has risen
more than the price of most other
goods and services. Despite the price
rise, more people are going to college
than before. Does this contradict the
law of demand?
Demand Application


The sale of heroin in the U.S. is a
serious crime. Does that mean that no
heroin is sold?
Since heroin is illegal, does that mean
that the price is higher than it would
be if it were legal?
Demand analysis

1.
2.
3.
4.
Which of the following would cause
an increase in the demand for
hairpieces (wigs) or hair replacement
treatment?
A rise in income.
A rise in the divorce rate.
A rise in the demand by many other
people.
A fall in the price of wigs.
Clever sales pitch

A British mobile-phone company
promised new subscribers in
November and December that all calls
on Christmas Day, December 25,
would be free. What would you expect
happened to the volume of calls that
day?
Question on
complementary effects

GE research showed that about 1980
the average size of the American
family was declining and so was the
average square footage of houses.
How would you think this impacted the
demand for appliances or the nature
of the appliances?
Looking Ahead

Some countries are going to
experience falling populations and
aging populations in the next several
decades. Japan will be one of the
hardest hit, and Italy, Spain, Greece
and Germany.
All else held equal, what major
changes in demand for various goods
and services are likely to occur?