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Unit 4 Demand Where do “prices” come from? How are prices determined in economic systems? Basic Terms in Economics: Demand “Demand” defined: “Demand is the combination of the willingness (have motivation) and ability (have money) among consumers to purchase at a particular price.” The Law of Demand Law of Demand: There is an inverse (opposite) relationship between the price of a good and the quantity consumers are willing to purchase. What helps explain this relationship??? The availability of substitutes - goods that do similar functions - explains this negative relationship $ What does the graph show? Inverse relationship! Q What else does the graph show? Law of Diminishing Utility As consumption increases, additional benefit decreases. – When benefits > costs: consumption continues – When benefits < costs: consumption ends Simply put, too much of something is a bad thing. This law also happens explain why the curve slopes downward. EXAMPLE: The first bottle of water satisfied your thirst. The second bottle made you feel totally full. The third bottle made you sick. The Law of Diminishing Utility Utility (happiness) Quantity Consumed Where do we get the data for our Demand Curve? From a “Market Demand Schedule” A market demand schedule is a table that shows the quantity of a good people will demand at different prices. CELL PHONE EXAMPLE Consider the market for cell phones (Verizon). A market demand schedule lays out the amount of cell phones that are demanded in the market for a spectrum of prices. We can graph these points (price and the demand for them) to make a demand curve for cell phones. Market Demand Schedule Price (monthly bill) Millions of Cell Phone (monthly bill) Subscribers Cell Phone Price $129 $109 $ 89 $ 69 $ 59 $ 49 $ 39 2.1 3.5 5.1 7.6 11.0 16.0 24.1 140 120 100 80 60 Assume this is for a unlimited minute & data package. 5 10 15 20 25 30 Quantity (of Cell Phone Subscribers) Market Demand Schedule Price (monthly bill) 140 •Notice how the law of demand is reflected by the shape of the demand curve. • As the price of a good rises … . . . consumers buy less. 120 100 80 Demand Curve 60 5 10 15 20 25 30 Quantity (of Cell Phone Subscribers) Demand Curve & Utility Price (monthly bill) The slope of the demand curve at any quantity shows the maximum price that consumers are WILLING and ABLE to pay for that additional unit. Q: What happens 140 Law of Diminishing Utility 120 100 80 60 as prices ↑ & Q ↓? A: utility diminishes 5 10 15 20 25 30 Quantity (of Cell Phone Subscribers) Demand Review • What is quantity demanded? • What does the law of diminishing utility state? • What is the law of demand? ELASTIC AND INELASTIC DEMAND The Demand & Price relationship is not the same for every product. LAW OF DEMAND: INVERSE RELATIONSHIP BETWEEN PRICE AND QUANTITY. …but sometimes the relationship between PRICE and a change in DEMAND is not as strong for some goods. : PRICE : PRICE WEAKER LAW RELATIONSHIP STRONGER LAW RELATIONSHIP LESS SUBSITITUTES MORE SUBSITITUTES Elasticity of Demand Elasticity is a measure of responsiveness between change in demand and a change in the price. It tells how much demand changes when you change the price. 2 Types of Elasticity: Inelastic Elastic Elastic Demand Elastic Demand: quantity demanded is sensitive to small price changes. Easy to substitute a good that has elastic demand. HAS MANY SUBSTITUTES When price increases, demand decreases (business revenue decreases) Example: price of a good with many substitutes, such as bottle water or soda. Inelastic Demand Inelastic Demand: quantity demanded is NOT sensitive to price changes. Hard to find substitutes for the good. HAS FEW OR NO SUBSTITUTES When price increases, business revenue increases Example: needed medication for an illness, such as Chemo-Therapy & gas. Elastic and Inelastic Demand Curves If the market price for gasoline was to rise from $1.00 to $5.00, the quantity demanded in the market decreases insignificantly (from 8 to 7 units). If the market price for tacos rises from $1.00 to $5.00, the quantity demanded in the market decreases significantly (from 8 to 1 unit). Taco demand is highly sensitive to price changes and can be described as elastic; gasoline demand is relatively insensitive to price changes and can be described as inelastic. 5.00 1.00 Gasoline INELASTIC 1 2 3 4 5 6 7 8 9 10 5.00 1.00 Tacos ELASTIC 1 2 3 4 5 6 7 8 9 10 Elasticity Over Time Short-Run - Consumers don’t have enough time to adjust to the price change in a short period of time (ex: stuck with the current product with no substitutes). Demand tends to be inelastic in the short-run Long-Run - Consumers have enough time to adjust in a longer period of time (ex: we will find a substitute to gas if the price remains high). Demand tends to be much more elastic in the long-run Review • What does elasticity measure? • What is elastic demand? • What is inelastic demand? • What is demand in short run? • What is demand in long run? “Changes in Demand” Versus “Changes in Quantity Demanded” What will cause the demand curve to shift? Changes in the Demand Curve versus Quantity Demanded Change in Demand Curve - shift OF the entire demand curve. A shift to the right = increase in demand $ Price 8.00 5.00 A shift to the left = decrease in demand 1.00 1 5 10 Quantity Change in Quantity Demanded movement ON the same demand curve due $ Price to a PRICE change. 5.00 1.00 1 5 10 Quantity THE DETERMINANTS OF DEMAND THE ONLY FACTORS THAT CAN CAUSE A DEMAND CURVE TO SHIFT TO THE LEFT (decrease) OR RIGHT (increase). $ Price 8.00 5.00 1.00 1 5 10 Quantity Position of the Demand Curve? What specific things determine the position of the demand curve? “P.O.I.N.T.” 1. 2. 3. 4. 5. Price of Related Products Outlook (Consumer Expectations) Income Number of consumers Tastes THE DETERMINANTS OF DEMAND 1. PRICE OF RELATED GOODS Substitute Goods: – As price of one rises other rises the demand for the – As price of one falls falls demand for the other Example: Dr. Thunder and Dr. Pepper. (assuming they taste the same) $ = D THE DETERMINANTS OF DEMAND 1. PRICE OF RELATED GOODS Complementary Goods: (they go well together) – As the price of one rises other falls the demand for the – As the price of one falls the demand for the other rises. Example: Gas, SUVs, and tires. Which way will the Demand curve for Tires shift? $ + DEMAND A: Shift to the left = DEMAND THE DETERMINANTS OF DEMAND 1. PRICE OF RELATED GOODS Substitutes vs Complements 2. OUTLOOK OF THE FUTURE This could work in numerous ways. For example: You hear there is going to be a recession so you stop spending today –OR– you hear that a sale on some clothing is ending soon so you run to make a purchase today. 3. INCOME INCOME effects Superior and Inferior Goods in different ways. Income Effects on Superior and Inferior Goods Superior Goods: – As income rises, demand will increase (shift right) – As income falls, demand will decrease (shift left) –Example: Expensive versus cheap cars Vs. Income Effects on Superior and Inferior Goods Inferior Goods: – As income rises demand falls – As income falls demand rises Example: Compact cars, MP3 Players, etc. THE DETERMINANTS OF DEMAND 1. PRICE OF RELATED GOODS Substitutes vs Complements 2. OUTLOOK OF THE FUTURE This could work in numerous ways. For example: You hear there is going to be a recession so you stop spending today –OR– you hear that a sale on some clothing is ending soon so you run to make a purchase today. 3. INCOME Superior vs Inferior Goods 4. NUMBER OF BUYERS 5. TASTES (Affected by attitudes, quality, advertising, etc.) DETERMINANTS OF DEMAND JOHN STOSSEL VIDEO Customer are getting even with help from the Internet. Focus on.. 1. How are customers getting back? 2. How has the Internet affected Elasticity of Demand? 3. How has the Internet affected any (or all) of the Determinates of Demand? Link to Video CHAPTER 4 DEMAND THE END STUDY FOR THE TEST