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Notes: Chapter 4- Demand
I.
Law of Demand
A. Demand
1.
To desire to own something and the ability to pay for it
2.
Does not factor in goods you can afford to buy (ex: a private
airplane)
B. Law of Demand
1.
↓ price: ↑ quantity demanded
2.
↑ price: ↓ quantity demanded
C. Substitution effect
1.
Consumers react to an increase in a good’s price by consuming
less of that good and more of other goods
2.
Ex: at lunch- pizzas vs. burgers
a. If price of pizza ↑ then people will buy less pizza and more
burgers
b. The opposite happens if price falls
D. Income effect
1.
Change in consumption resulting from a change in real income
2.
In short, people buy less if they do not have as much money
E. Consumption
1.
is defined as the amount bought
2.
NOT amount spent
II.
Demand Schedule and Demand Curve
A. Demand schedule: a table that lists the quantity of a good a person will buy at
each price
B. Market demand schedule
1.
Table that shows the quantity of a good all consumers in a market
will buy at each different price
2.
This is important for businesses to know how much they can have
to be bought
C. Demand curve
1.
Graphic representation of a demand schedule
a. Basically take the information from a demand schedule and
graph it
b. Always slopes downward from left to right
2.
Always label:
a. Vertical axis (y): price
b. Horizontal axis (x): # of items
D. Assumption that other variables are constant
1.
Ceteris paribus: Latin phrase that means “all other things held
constant”
2.
When we look at this we look only at quantity demanded
3.
When other factors are taken into account the curve shifts and this
a change in demand
1
III.
Shifts in Demand
A. Income
1.
Normal good
a. A good consumers demand more of when their incomes
increase
b. Most goods fall under this category
2.
Inferior good
a. A good that consumers demand less of when their incomes
increase
b. Ex: Ramen noodles, generic brands, and used cars
B. Consumer expectations
1.
If prices are expected to increase in the future, the more likely it
will be bought sooner than later
2.
If the price is expected to fall then the consumer will wait
C. Population
1.
More people = more demand
2.
Ex: Baby Boomers in the 1950s and 1960s created a huge demand
on a variety of goods and services
D. Consumer tastes and advertising
1.
Fads and trends
2.
Heavily influenced by advertising
E. Price of related goods
1.
Compliments
a. Two goods that are bought and used together
b. Ex: shaving cream and razors
2.
Substitutes
a. Goods that are used in place of one another
b. Ex: using edge gel in place of shaving cream
IV.
Elasticity of Demand
A. A measure of how consumers react to a change in price
B. A good can be both elastic and inelastic depending on the price
C. Inelastic: demand is not very sensitive to a change in price
D. Elastic: demand is very sensitive to a change in price
E. Elasticity of demand = % change in quantity demanded
% change in price
Percent change = original # - new #
original #
F. If a good is
elastic- >1
G. If a good is
inelastic <1
H. If a good is unitary elastic = 1
V.
Factors Affecting Elasticity
2
X
100
A. Availability of substitutes
1.
Ex: for prescription drugs if there is lots of substitutes it is elastic,
if few (if any) substitutes it is inelastic
B. Relative importance
1.
How much of your budget do you spend on the good
C. Necessities vs. luxuries
1.
Necessities tend to be more inelastic
2.
Luxuries tend to be more elastic
D. Change over time
1.
Sometimes it takes a while for consumers to react to changes in
price
2.
Ex: if gas increases it will take a will for people to shift to fuel
efficient cars
VI.
Elasticity and Revenue
A. Total revenue
1.
Amount of money a firm receives by selling goods or services
2.
A firm can lose money by raising prices because demand decreases
3.
But if the demand is inelastic firms can raise price because people
will still buy it
4.
Thus, it is very important to know if a good is elastic or inelastic
B. Elastic
1.
↓ price ↑ revenue
2.
↑ price ↓ revenue
C. Inelastic
1.
↓ price ↓ revenue
2.
↑ price ↓ revenue
3