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Chapter 4: Demand Section 1 Understanding Demand

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Title: Chapter 4: Demand Section 1 Understanding Demand


1
Chapter 4 DemandSection 1Understanding Demand
2
Section 1 Objectives
  1. Explain the law of demand.
  2. Describe how the substitution effect and the
    income effect influence decisions.
  3. Create a demand schedule for an individual and a
    market.
  4. Interpret a demand graph using demand schedules.

3
Imagine for a second
  • Your daily routine involves going to Stuft Pizza
    and purchasing two slices of pizza for a dollar
    each.
  • Today you go to Stuft, and HALLELUJAH!!! The
    price of pizza has gone down to 50 cents!!!! How
    many pieces would you buy now?
  • Tomorrow, Stuft realizes that they lost their
    shirts so they need to raise the price to 2 a
    slice, how many pieces would you buy?

4
Understanding Demand
  • Demand the desire to own something and the
    ability to pay for it
  • Law of Demand consumers will buy more of a good
    when its price is lower and less when its price
    is higher

5
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6
  • How does the law of demand affect the quantity
    demanded?
  • Price changes always affect the quantity demanded
    because people buy less of a good when the price
    goes up.
  • By analyzing demand schedules and demand curves,
    you can see how consumers react to changes in
    price.

7
Demand
  • The law of demand is the result of the
    substitution effect and the income effect --two
    ways that a consumer can change his or her
    spending patterns. Together, they explain why an
    increase in price decreases the amount consumers
    purchase.

8
Law of Demand is a product of several patterns of
behavior
  • substitution effect when consumers react to an
    increase in a goods price by consuming less of
    that good and more of a substitute good
  • income effect the change in consumption that
    results when a price increase causes real income
    to decline

9
The Substitution Effect
  • The substitution effect takes place when a
    consumer reacts to a rise in the price of one
    good by consuming less of that good and more of a
    substitute good. The substitution effect can also
    apply to a drop in prices.

10
The Income Effect
  • The income effect is the change in consumption
    that results when a price increase causes real
    income to decline.
  • Economists measure consumption in the amount of a
    good that is bought, not the amount of money
    spent on it.
  • The income effect also operates when the price is
    lowered. If the price of something drops, you
    feel wealthier. If you buy more of a good as a
    result of a lower price, thats the income effect
    at work.

11
The Demand Schedule
  • Demand Schedule a table that lists the quantity
    of a good a person will buy at various prices in
    a market
  • In order to have demand you must be willing and
    able to buy a good at the specified price

12
Market Demand Schedule
  • Market Demand Schedule a table that lists the
    quantity of a good all consumers in a market will
    buy at various prices
  • Market demand schedules are used to predict the
    total sales of a commodity at several different
    prices.
  • Market demand schedules exhibit the law of
    demand at higher prices the quantity demanded is
    lower.

13
The Demand Curve
  • Demand Curve a graphic representation of a
    demand schedule
  • The vertical axis is always labeled with the
    lowers possible prices at the bottom and the
    highest prices at the top.
  • The horizontal axis should be labeled with the
    lowest possible quantity demanded at the left and
    the highest possible quantity demanded on the
    right.

14
Demand Curves
15
Demand Curves
  • All demand schedules and demand curves reflect
    the law of demand.
  • Market demand curves are only accurate for one
    very specific set of market conditions. They
    cannot predict changing market conditions
  • Demand curve can only give info on how buying
    habits will change based on price changes of a
    good.

16
Another Example
0
  • Example Helens demand for lattes.
  • Notice that Helens preferences obey the Law of
    Demand.

Price of lattes Quantity of lattes demanded
0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
17
Helens Demand Schedule Curve
0
Price of lattes Quantity of lattes demanded
0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
18
Market Demand versus Individual Demand
0
  • The quantity demanded in the market is the sum of
    the quantities demanded by all buyers at each
    price.
  • Suppose Helen and Ken are the only two buyers in
    the Latte market. (Qd quantity demanded)

Market Qd
18
19
The Market Demand Curve for Lattes
0
P
P Qd (Market)
0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
Q
20
Review
  • Now that you have learned how the law of demand
    affect the quantity demanded, go back and answer
    the Chapter Essential Question.
  • How do we decide what to buy?

21
Chapter 4 DemandSection 2Shifts in the Demand
Curve
22
Objectives
  1. Explain the difference between a change in
    quantity demanded and a shift in the demand
    curve.
  2. Identify the factors that create changes in
    demand and that can cause a shift in the demand
    curve.
  3. Give an example of how a change in demand for one
    good can affect demand for a related good.

23
When you Assume?
  • ceteris paribus a Latin phrase that means all
    things held under constraint
  • Pizza example
  • Assumed only price would change
  • All else held constant
  • We must also consider impact of other changes on
    demand

24
Changes in Demand
  • A demand schedule takes into account only changes
    in price.
  • A demand curve is accurate only as long as there
    are no changes other than price that could affect
    the consumers decision.
  • When we drop the ceteris paribus rule and allow
    other factors to change
  • Shifts in demand curve change in demand

25
You gotta me shiftin me!
  • Why does the demand curve shift?
  • Shifts in the demand curve are caused by more
    than just price increases and decreases. Other
    factors include
  • Buyers
  • Income
  • Tastes
  • Expectations
  • Related Goods

26
Graphing Changes in Demand
  • When factors other than price cause demand to
    fall, the demand curve shifts to the left. An
    increase in demand appears as a shift to the
    right.

27
Change in Demand Factors
  • Income
  • A consumers income affects their demand for most
    goods
  • normal good a good that consumers demand more of
    when their income increases most goods are
    normal goods.
  • What you want
  • inferior good a good that consumers demand less
    of when their income increases
  • What I can afford

28
Consumer Expectations
  • Checkpoint How will an anticipated rise in price
    affect consumer demand for a good?
  • The current demand for a good is positively
    related to its expected future price.
  • If you expect the price to rise, your current
    demand will rise, which means you will buy the
    good sooner.
  • If you expect the price to drop your current
    demand will fall, and you will wait for the lower
    price.

29
Population
  • Changes in the size of the population will also
    affect the demand for most products.
  • Population trends can have a particularly strong
    effect on certain goods.
  • Baby Boom two cycle effect

30
Demand Curve Shifters of Buyers
0
Suppose the number of buyers increases. Then,
at each P, Qd will increase (by 5 in this
example).
31
Consumer Tastes Advertising
  • Demographics the statistical characteristics of
    populations and population segments, especially
    when used to identify consumer markets
  • Businesses use this data to classify potential
    customers.
  • Demographics also have a strong influence on
    packaging, pricing, and advertising.

32
Change in Tastes
  • Example The Atkins diet became popular in the
    90s, caused an increase in demand for eggs,
    shifted the egg demand curve to the right.

33
Consumer Tastes continued
  • Hispanics, or Latinos are now the largest
    minority group in the United States.
  • Firms have responded to this shift by providing
    products and services for the growing Hispanic
    population.
  • Firms can also cause shifts by their advertising
    creating a demand for a good

34
Prices of Related Goods
  • The demand curve for one good can also shift in
    response to a change in demand for another good.
  • There are two types of related goods that
    interact this way
  • Complements are two goods that are bought and
    used together.
  • Substitutes are goods that are used in place of
    one another.

35
Summary Variables That Influence Buyers
0
  • Variable A change in this variable

Price causes a movement along the D
curve of buyers shifts the D
curve Income shifts the D curve Price ofrelated
goods shifts the D curve Tastes shifts the D
curve Expectations shifts the D curve
36
A C T I V E L E A R N I N G 1 Demand Curve
Draw a demand curve for music downloads. What
happens to it in each of the following
scenarios? Why?
  • A. The price of iPods falls
  • B. The price of music downloads falls
  • C. The price of CDs falls

36
37
A C T I V E L E A R N I N G 1 A. Price of
iPods falls
Music downloads and iPods are complements. A
fall in price of iPods shifts the demand curve
for music downloads to the right.
37
38
A C T I V E L E A R N I N G 1 B. Price of
music downloads falls
Price of music down-loads
The D curve does not shift. Move down along
curve to a point with lower P, higher Q.
P1
D1
Q1
Quantity of music downloads
38
39
A C T I V E L E A R N I N G 1 C. Price of
CDs falls
CDs and music downloads are substitutes. A
fall in price of CDs shifts demand for music
downloads to the left.
Price of music down-loads
Quantity of music downloads
39
40
Review
  • Now that you have learned why the demand curve
    shifts, go back and answer the Chapter Essential
    Question.
  • How do we decide what to buy?

41
Chapter 4 DemandSection 3Elasticity of Demand
42
Objectives
  1. Explain how to calculate elasticity of demand.
  2. Identify factors that effect elasticity.
  3. Explain how firms use elasticity and revenue to
    make decisions.

43
Questions
  • Are there goods that you would always find money
    to buy, even if the price were ti rise
    drastically?
  • Are there other goods that you would cut back on,
    or even stop buying altogether, if the price were
    to raise slightly?

44
ELASTICITY
  • Economists describe the way that consumers
    respond to price changes as elasticity of demand
  • elasticity of demand a measure of how consumers
    respond to price changes

45
Sensitive to price change
  • Elastic describes demand that is very sensitive
    to a change in price
  • Ex apple juice, electronics, bottled water

46
Not sensitive to price change
  • Inelastic describes demand that is not very
    sensitive to price changes
  • Ex concert tickets, life saving medicine

47
Values of Elasticity
  • Inelastic if elasticity of demand is less than 1
  • Elastic if elasticity of demand is greater than 1
  • If elasticity is equal to 1, then we describe
    demand as unitary elastic
  • Now lets look at how we calculate elasticity

48
What is the homeowners elasticity of demand for
gasoline? What factor affected elasticity?
49
When Calculating Elasticity of Demand
  • The law of demand implies that the result will
    always be negative. This is because increases in
    the price of a good will always decrease the
    quantity demanded, and a decrease in the price of
    a good will always increase the quantity
    demanded.
  • We will always convert to a positive solution,
    drop the negative sign

50
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51
You try now!
  • Marios consumption of tacos
  • Mario consumes 4 tacos when the price is 1
  • Mario consumes 3 tacos when the price is 1.50
  • Calculate Marios elasticity of demand for tacos.
  • What does this mean?
  • Beccas consumption of cupcakes
  • When the price of cupcakes rises by 40
  • Beccas quantity demanded falls by 60
  • What is the elasticity of demand for Becca?
  • What does this mean?

52
Last one, just for good measure
  • Alberto LOVES Teen Beat Magazine
  • When the price is 2 he buys 4 magazines (He is a
    serious collector)
  • When the price is raised to 3 he consumes 2
    magazines (He loves the magazine, but he does
    have to eat)
  • What is the elasticity of demand?
  • What does it tell us?

53
Factors affecting elasticity
  • Elastic Demand comes from one or more of these
    factors
  • The availability of substitute goods
  • Relative Importance
  • Change over time
  • Necessities vs. Luxuries

54
Factors Affecting Elasticity
  • Availability of Substitutes
  • If there are a few substitutes for a good, then
    even when its price rises greatly, you might
    still buy it.
  • If the lack of substitutes can make demand
    inelastic, a wide choice of substitute goods can
    make demand elastic.

55
Other Factors
  • Relative Importance
  • A second factor in determining a goods
    elasticity of demand is how much of your budget
    you spend on a good.
  • How much you need it vs. wanting it
  • Necessities v. Luxuries
  • Whether a person considers a good to be a
    necessity or a luxury has a great impact on a
    persons elasticity of demand for that good
  • Luxuries goods are generally more elastic

56
Other Factors, cont.
  • Change Over Time
  • Consumers do not always react quickly to a price
    increase, because it takes time to find
    substitutes. Because they cannot respond quickly
    to price changes, their demand is inelastic in
    the short term.
  • Demand sometimes becomes more elastic over time
    as people eventually find substitutes.
  • Example Car purchase as gas prices fluctuate

57
Total Revenue
  • Elasticity is important to the study of economics
    because elasticity helps us measure how consumers
    respond to price changes for different products.
  • The elasticity of demand determines how a change
    in price will affect a firms total revenue or
    income.
  • Total Revenue the total amount of money a
    company receives by selling goods or services

58
Total Revenue and Elastic Demand
  • The law of demand states that an increase in
    price will decrease the quantity demanded.
  • When a good has elastic demand, raising the price
    of each unit sold by 20 will decrease the
    quantity sold by a larger percentage. The
    quantity sold will drop enough to reduce the
    firms total revenue.
  • The same process can also work in reverse.

59
Remember
  • Elastic Demand comes from one or more of these
    factors
  • Availability of substitute goods
  • A limited budget that does not allow price
    changes
  • The perception of the good as a luxury item
  • If these conditions are present then the demand
    for a good is elastic

60
Total Revenue and Inelastic Demand
  • If demand is inelastic, consumers demand is not
    very responsive to price changes. If prices
    increase, the quantity demanded will decrease,
    but by less than the percentage of the price
    increase. This will result in higher total
    revenues.

61
Elasticity and Revenue
  • Elasticity of demand determines the effect of a
    price change on total revenues.
  • Why will revenue fall if a firm raises the price
    of a good whose demand is elastic?
  • What happens to total revenue when price
    decreases, but demand is inelastic?

62
Elasticity and Price Policies
  • Checkpoint Why does a firm need to know whether
    demand for its product is elastic or inelastic?
  • Knowledge of how the elasticity of demand can
    affect a firms total revenues helps the firm
    make pricing decisions that lead to the greatest
    revenue.
  • If a firm knows that the demand for its product
    is elastic at the current price, it knows that an
    increase in price would reduce total revenue.
  • If a firm knows that the demand for its product
    is inelastic at its current price, it knows that
    an increase in price will increase total revenue.

63
Review
  • Now that you have learned what factors affect
    elasticity of demand, go back and answer the
    Chapter Essential Question.
  • How do we decide what to buy?

64
Practice makes perfect!
  • 1) Yesterday, the price of envelopes was 3 a
    box, and Julie was willing to buy 10 boxes.
    Today, the price has gone up to 3.75 a box, and
    Julie is now willing to buy 8 boxes. Is Julie's
    demand for envelopes elastic or inelastic? What
    is Julie's elasticity of demand?
  • 2) If Neil's elasticity of demand for hot dogs is
    constantly 0.9, and he buys 4 hot dogs when the
    price is 1.50 per hot dog, how many will he buy
    when the price is 1.00 per hot dog?

65
Just a little bit more!
  • 3) Which of the following goods are likely to
    have elastic demand, and which are likely to have
    inelastic demand? Home heating oil , Pepsi ,
    Chocolate , Water , Heart medication Oriental
    rugs
  • 4) Katherine advertises to sell cookies for 4 a
    dozen. She sells 50 dozen, and decides that she
    can charge more. She raises the price to 6 a
    dozen and sells 40 dozen. What is the elasticity
    of demand? Assuming that the elasticity of demand
    is constant, how many would she sell if the price
    were 10 a box?

66
Answers please
  • 1) To find Julie's elasticity of demand, we need
    to divide the percent change in quantity by the
    percent change in price. Change in Quantity
    (8 - 10)/(10) -0.20 -20 Change in Price
    (3.75 - 3.00)/(3.00) 0.25 25 Elasticity
    (-20)/(25) -0.8 0.8 Her elasticity of
    demand is the absolute value of -0.8, or 0.8.
    Julie's elasticity of demand is inelastic, since
    it is less than 1.

67
  • 2) This time, we are using elasticity to find
    quantity, instead of the other way around. We
    will use the same formula, plug in what we know,
    and solve from there. Elasticity And, in the
    case of John, Change in Quantity (X 4)/4
    Therefore Elasticity 0.9 ((X 4)/4)/(
    Change in Price) Change in Price (1.00 -
    1.50)/(1.50) -33 0.9 (X 4)/4)/(-33)
    ((X - 4)/4) 0.3 0.3 (X - 4)/4 X 5.2
    Since Neil probably can't buy fractions of hot
    dogs, it looks like he will buy 5 hot dogs when
    the price drops to 1.00 per hot dog.

68
  • 3) Elastic demand Pepsi, chocolate, and Oriental
    rugs Inelastic demand Home heating oil, water,
    and heart medication

69
  • 4) To find the elasticity of demand, we need to
    divide the percent change in quantity by the
    percent change in price. Change in Quantity
    (40 - 50)/(50) -0.20 -20 Change in Price
    (6.00 - 4.00)/(4.00) 0.50 50 Elasticity
    (-20)/(50) -0.4 0.4 The elasticity of
    demand is 0.4 (elastic). To find the quantity
    when the price is 10 a box, we use the same
    formula Elasticity 0.4 ( Change in
    Quantity)/( Change in Price) Change in Price
    (10.00 - 4.00)/(4.00) 1.5 150 Remember
    that before taking the absolute value, elasticity
    was -0.4, so use -0.4 to calculate the changes in
    quantity, or you will end up with a big increase
    in consumption, instead of a decrease! -0.4
    ( Change in Quantity)/(150) (Change in
    Quantity) -60 -0.6 -0.6 (X - 50)/50 X
    20
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