Demand

Chapter 4: Demand

Demand

Demand means the willingness and capacity to pay.

Prices are the tools by which the market coordinates individual desires.

The Law of Demand

Law of demand – there is an inverse relationship between price and quantity demanded. Quantity demanded rises as price falls, other things

constant. Quantity demanded falls as prices rise, other things

constant.

Demand in Output Markets

A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.

Demand curves are usually derived from demand schedules.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

The Demand Curve

The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

SUMMARYThe Law of Demand

• The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

• This means that This means that demand curves slope demand curves slope downward.downward.

Demand vs. Quantity Demanded

Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time.

The quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

Change in Quantity Demanded

D1

Change in quantity demanded

(a movement along the curve)

B

0

Pri

ce (

per

uni

t)

Quantity demanded (per unit of time)100

$2

$1

200

A

A shift in demand is the graphical representation of the effect of anything other than price on demand.

Shifts in Demand Versus Movements Along a

Demand Curve

SUMMARY

• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level.

A Change in Demand Versus a Change in Quantity Demanded

Shifts of the Demand Curve

A “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3)

Price

Quantity

D3

D1

D2

Increase in demand

Decrease in demand

An “increase in demand” means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1D2)

Shift Factors of Demand

Shift factors of demand are factors that cause shifts in the demand curve: Society's income. The prices of other goods. Tastes. Expectations. Number of Buyers Taxes on subsidies to consumers. Temporary change in the economy

SUMMARY

Related Goods and Services

• Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products.

• Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

SUMMARYThe Impact of a Change in the Price of Related Goods

• Price of hamburger rises

• Demand for complement good (ketchup) shifts left

• Demand for substitute good (chicken) shifts right

• Quantity of hamburger demanded falls

SUMMARY

The Impact of a Change in Income• Higher income decreases the

demand for an inferior good• Higher income increases

the demand for a normal good

An Increase in Demand An increase in the

population and other factors generate an increase in demand – a rise in the quantity demanded at any given price.

This is represented by the two demand schedules - one showing demand in 2002, before the rise in population, the other showing demand in 2006, after the rise in population.

7.17.58.18.9

10.011.514.2

8.59.09.7

10.712.013.817.0

in 2002 in 2006

$2.001.751.501.251.000.750.50

Price of coffee beans (per

pound)

Quantity of coffee beans demanded

(billions of pounds)

Demand Schedules for Coffee Beans

An Increase in Demand

A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

Increase in Increase in population population more coffee more coffee

drinkersdrinkers

Price of coffee

beans (per gallon)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D1 D2

Demand curve in 2006

Demand curve in 2002

Quantity of coffee beans (billions of

pounds)

What Causes a Demand Curve to Shift?

Changes in Income Normal Goods: When a rise in income increases the

demand for a good - the normal case - we say that the good is a normal good.

Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.

SUMMARYA Change in Demand Versus a Change in Quantity Demanded

To summarize:

Change in price of a good or service

leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

SUMMARYFrom Household to Market Demand

• Demand for a good or service can be defined for an individual household, or for a group of households that make up a market.

• Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Individual Demand Curve and the Market Demand Curve

The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market.

DDarla DDino

0 0 10 203020 0

$2

1

$2

1

$2

1

30 40 50

DMarket

(a)

Darla’s Individual Demand Curve

(b)

Dino’s Individual Demand Curve

(c)

Market Demand Curve

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

SUMMARY

Elasticity . . .

• … allows us to analyze supply and demand with greater precision.

• … is a measure of how much buyers and sellers respond to changes in market conditions

SUMMARY

THE ELASTICITY OF DEMAND

• Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

• Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

SUMMARY

Determinates of Demand Easticity

• Can the purchase be delayed?• Are Adequate Substitutes Available?• Does the Purchase Use a Large % of Income?

SUMMARY

The Price Elasticity of Demand and Its Determinants

• Demand tends to be more elastic :– the larger the number of close substitutes.– if the good is a luxury.– if the purchases represents a large portion of income.

SUMMARY

Computing the Price Elasticity of Demand

• The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in p rice

SUMMARY

• Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

Computing the Price Elasticity of DemandP rice e las tic ity o f d em an d =

P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in p rice

( )

( . . ).

1 0 81 0

1 0 0

2 2 0 2 0 02 0 0

1 0 0

2 0 %

1 0 %2

SUMMARY

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities

*The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.

P rice e las tic ity o f d em an d =( ) / [( ) / ]

( ) / [( ) / ]

Q Q Q QP P P P2 1 2 1

2 1 2 1

2

2

SUMMARY

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities

• Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

( )( ) /

( . . )( . . ) /

..

1 0 81 0 8 2

2 2 0 2 0 02 0 0 2 2 0 2

2 2 %

9 5 %2 3 2

SUMMARY

The Variety of Demand Curves

• Inelastic Demand– Quantity demanded does not respond strongly to price

changes.– Price elasticity of demand is less than one.

• Elastic Demand– Quantity demanded responds strongly to changes in

price.– Price elasticity of demand is greater than one.

SUMMARY

The Variety of Demand Curves

• Perfectly Inelastic– Quantity demanded does not respond to price changes.

• Perfectly Elastic– Quantity demanded changes infinitely with any change in

price.

• Unit Elastic– Quantity demanded changes by the same percentage as

the price.

SUMMARY

Income Elasticity of Demand

• Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.

• It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

SUMMARY

Income Elasticity

• Goods consumers regard as necessities tend to be income inelastic– Examples include food, fuel, clothing, utilities, and

medical services.

• Goods consumers regard as luxuries tend to be income elastic.– Examples include sports cars, furs, and expensive foods.