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DEMAND LECTURE IIDEMAND LECTURE II
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LETS LOOK AT THE COMMODITY LETS LOOK AT THE COMMODITY WHEATWHEAT
Price Price SurplusSurplus
PP1 1 SupplySupply
PPee DemandDemand
QQee Quantity / unit of Quantity / unit of
timetime
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A SURPLUSA SURPLUS
A. PA. Pee and Q and Qee represent the market represent the market
clearing price and quantity.clearing price and quantity.
B. Assume the government sets a price atB. Assume the government sets a price at
PP11::
1. There is a surplus of goods.1. There is a surplus of goods.
2. Price must fall for the market to2. Price must fall for the market to
clear.clear.
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LETS LOOK AT THE COMMODITY LETS LOOK AT THE COMMODITY GASOLINEGASOLINE
Price Price
SupplySupply
PPee DemandDemand
PP22
ShortageShortage
QQee Quantity / unit of timeQuantity / unit of time
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A SHORTAGEA SHORTAGE
C. Assume the government sets a price C. Assume the government sets a price at at
PP22::
1. There is a shortage of goods.1. There is a shortage of goods.
2. Price must rise for the market 2. Price must rise for the market toto
clear.clear.
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SURPLUS AND SCARCITY?SURPLUS AND SCARCITY?
D. We could have a surplus and still D. We could have a surplus and still have a scarce commodity, RIGHT ?have a scarce commodity, RIGHT ?
1. Yes. This is due to there not1. Yes. This is due to there not
being enough goods to meetbeing enough goods to meet
demand at a price of zero.demand at a price of zero.
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DETERMINANTS OF DEMANDDETERMINANTS OF DEMAND
As a commodity's own price changes, As a commodity's own price changes, we move along the existing demand we move along the existing demand
curve. (Law of Demand)curve. (Law of Demand)
A.A. Other factors affect the demandOther factors affect the demand
curves position, shape, and curves position, shape, and slope.slope.
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DETERMINANTS OF DEMANDDETERMINANTS OF DEMAND
These other determinants, in addition These other determinants, in addition to the commodity's own price are:to the commodity's own price are:
a. Consumer disposable income.a. Consumer disposable income.
b. Price of substitutes.b. Price of substitutes.
c. Price of complements.c. Price of complements.
d. Consumer preferences.d. Consumer preferences.
e. Expectations about the e. Expectations about the future.future.
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DETERMINANTS OF DEMANDDETERMINANTS OF DEMAND
f. Changes in the population.f. Changes in the population.
g. Weather.g. Weather.
h. Length of adjustment period. h. Length of adjustment period.
i. Availability of substitutes.i. Availability of substitutes.
j. Proportion of the consumer’sj. Proportion of the consumer’s
budget that a particular good budget that a particular good
represents.represents.
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Consumer’s Disposable Consumer’s Disposable IncomeIncome
1. If we increase consumer's 1. If we increase consumer's disposable income ceteris paribus,disposable income ceteris paribus,
what happens?what happens?
· He/she is able to purchase · He/she is able to purchase more atmore at
all price levels.all price levels.
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2. The demand curve 2. The demand curve shifts to the right.shifts to the right.
PricePrice
DD11
DD00
QuantityQuantity
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3. If we decrease the consumer's disposable income ceteris paribus, what happens ?
· The consumer cannot purchase the same amount of the commodity as before, over the entire range of prices.
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4. The demand curve is 4. The demand curve is said to shift to the left.said to shift to the left.
PricePrice
DD00
DD11
QuantityQuantity
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5. Associated with this income effect, we can create another sub-classification for commodities:
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Normal Goods or ServicesNormal Goods or Services
An Increase in disposable An Increase in disposable income, shifts Demand curve income, shifts Demand curve right.right.
Id Id DemandDemand
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PricePrice
DD11
DD00
QuantityQuantity
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Normal Goods or ServicesNormal Goods or Services
A Decrease in disposable income A Decrease in disposable income shifts shifts Demand curve leftDemand curve left
Id Id DemandDemand
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PricePrice
DD00
DD11
QuantityQuantity
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Inferior Good or ServiceInferior Good or Service
An Increase in disposable An Increase in disposable income shifts income shifts curve left.curve left.
Id Id DemandDemand
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PricePrice
DD00
DD11
QuantityQuantity
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Inferior Good or ServiceInferior Good or Service
A Decrease in disposable income A Decrease in disposable income shifts curve right.shifts curve right.
Id Id DemandDemand
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PricePrice
DD11
DD00
QuantityQuantity
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Inferior Good or ServiceInferior Good or Service
Examples:Examples:
Macaroni and cheese dinners,Macaroni and cheese dinners, potatoes,potatoes, and riceand rice ROAD KILL !!ROAD KILL !!
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Change in the price of Change in the price of substitutes, ceteris substitutes, ceteris paribus:paribus:An increase in the price of a An increase in the price of a
substitute will result in an substitute will result in an increase in the increase in the demanddemand for the for the commodity of interest (COI) commodity of interest (COI)
(demand shifts right).(demand shifts right).
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For example, lets look at For example, lets look at beef while considering sheep beef while considering sheep
as a substitute:as a substitute: Let the quantity of Sheep available Let the quantity of Sheep available
become restricted. What become restricted. What happens?happens?
· There is an increase in the price of · There is an increase in the price of sheep.sheep.
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Increase in price of Sheep Increase in price of Sheep due to a decrease in Supply due to a decrease in Supply of Sheep:of Sheep:
Price SPrice S1 1 S S0 0 sheep Marketsheep Market
PP11
PP00
DD
QQ11 Q Q00
Qd of pork/utQd of pork/ut
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There is an increase in the There is an increase in the demand for beef (COI) because demand for beef (COI) because of the increase in the price of of the increase in the price of sheep (SUBSTITUTE).sheep (SUBSTITUTE).
Price SPrice S0 0 Sheep Sheep MarketMarket
PP11
PP00
DD11
DD00
QQ00
Qd of beef/utQd of beef/ut
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D1
D0
S0
P0
P1
BEEFS1 S0
D0P0
P1
Sheep
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Substitutes:Substitutes:
Therefore, an increase in the price of Therefore, an increase in the price of a substitute will shift the entire a substitute will shift the entire demand curve of the commodity of demand curve of the commodity of interest to the right.interest to the right.
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Substitutes:Substitutes:
A decrease in the price of a A decrease in the price of a substitute will shift the entire substitute will shift the entire demand curve of the commodity of demand curve of the commodity of interest to the left.interest to the left.
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Substitutes:Substitutes:
Immediate effect of a supply Immediate effect of a supply restriction for the substitute is a restriction for the substitute is a price increase.price increase.
This will affect the demand curve for This will affect the demand curve for the COI by increasing demand the COI by increasing demand (shifts to the right) for the COI.(shifts to the right) for the COI.
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Substitutes:Substitutes:
Immediate effect of Immediate effect of a increase in a increase in supply is a price supply is a price reduction.reduction.
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Substitutes:Substitutes:
PPsubsub DDCOICOI
ANDAND
PPsub sub DDCOICOI
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Reflect Back:Reflect Back:
We have talked about what has happened in agriculture when wage rates have increased. Capital and labor are substitutes for each other.
We have discussed that as the wage rate has increased, the demand for capital has increased.
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Change in the price of a Change in the price of a complement, ceteris complement, ceteris paribus:paribus:Complements are Complements are
goods that go goods that go together, such as:together, such as:
left and right shoes,left and right shoes, gas and cars,gas and cars, milk and cereal,milk and cereal, bread and butter,bread and butter, guns and ammo,guns and ammo, etc.etc.
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Compliments:Compliments:
If the price of a complement If the price of a complement increases, then the demand for the increases, then the demand for the COICOI decreases. decreases.
PPcompcomp DDCOICOI
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Compliments:Compliments:
Price Price Let the price of milk increase.Let the price of milk increase.
Since cereal is a complement of Since cereal is a complement of milk,milk,
its demand will decreaseits demand will decrease..
DD00
DD11
Qd/utQd/ut
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Compliments:Compliments:
If the price of a complement If the price of a complement decreases, the demand for the decreases, the demand for the COI COI increases.increases.
PPcompcomp DDCOICOI
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Compliments:Compliments:
Price Price Let the price of milk decrease.Let the price of milk decrease.
Since cereal is a complement Since cereal is a complement of milk,of milk,
its demand will increaseits demand will increase..
DD11
DD00
Qd/utQd/ut
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Consumer preferences Consumer preferences and tasteand taste
As preferences change the demand As preferences change the demand curve will also change.curve will also change.
For example: What would be the For example: What would be the result of the following statements, result of the following statements, if true, on the demand curve for if true, on the demand curve for each commodity ?each commodity ?
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Animal fat leads to a Animal fat leads to a higher risk of heart higher risk of heart attacks.attacks.
Price Price Result: Result: Demand for red meatDemand for red meat
DD00
DD11
Qd/utQd/ut
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Nitrites in bacon have Nitrites in bacon have been linked to cancer.been linked to cancer.
Price Price Result: Result: Demand for baconDemand for bacon
DD00
DD11
Qd/utQd/ut
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Increasing fiber in the diet Increasing fiber in the diet reduces the chance of reduces the chance of getting colon cancer.getting colon cancer.
PricePrice
DD11
DD00
Quantity / unit of timeQuantity / unit of time
Result: Demand for high fibercereals and popcorn.
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Trichinae can be Trichinae can be eliminated in Sheep by a eliminated in Sheep by a new irradiation processnew irradiation process
PricePrice
DD00
Quantity / unit of timeQuantity / unit of time
Result: ???????
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National Inquirer says that people National Inquirer says that people who own and care for rose bushes who own and care for rose bushes live 20 years longer than the average live 20 years longer than the average person.person.
PricePrice
DD11
DD00
Quantity / unit of timeQuantity / unit of time
Result: Demand for rose bushes
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Expectations about the Expectations about the futurefuture
The peanut butter The peanut butter scare: scare:
a news release said a news release said that the peanut that the peanut crop would be short crop would be short that year and that year and peanut butter prices peanut butter prices were expected to were expected to double.double.
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Expectations about the Expectations about the futurefuture
Result:Result:
People bought 3 lbs. of peanut butter People bought 3 lbs. of peanut butter that month instead of 1lb. that month instead of 1lb.
Demand for peanut butter.Demand for peanut butter.
Due to Expectations of higher Price.Due to Expectations of higher Price.
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Expectations: The Self-Expectations: The Self-Fullfilling Prophecy !Fullfilling Prophecy !
Since consumers expect prices to Since consumers expect prices to increase, they all run out to buy increase, they all run out to buy NOW.NOW.
This causes demand to increase, and This causes demand to increase, and prices are pushed up very quickly!prices are pushed up very quickly!
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Graphically Speaking:Graphically Speaking:PricePrice
$2.00$2.00
DD11
DD00
1 3 1 3
lbs. per lbs. per monthmonth
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NOTE:NOTE:
If the commodity we were If the commodity we were analyzing was not analyzing was not storable, then the storable, then the demand curve may demand curve may NOTNOT shift.shift.
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Changes in the population Changes in the population of consumersof consumers
PricePrice
DD11
DD00
Quantitiy/unit Quantitiy/unit timetime
Increase in population will result in increase in Demand for G&S.
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Changes in the population Changes in the population of consumersof consumers
Price Price
DD00
DD11
Quantitiy/unit timeQuantitiy/unit time
Decrease in population will result in decrease in Demand for G&S.
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Length of the Adjustment Length of the Adjustment PeriodPeriod
This is tied to, or related to the availability of This is tied to, or related to the availability of substitutessubstitutes..
PricePriceShort Run: Consumers have little time to find suitable substitues.
D
Quantity per Unit of Time
Demand is not very sensitiveto price changes, c.p.
We say demand is relatively inelastic
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Length of the Adjustment Length of the Adjustment PeriodPeriod
PricePrice
D
Quantity Demanded per Unit of Time
Long Run: Consumers have time to find suitable substitutes.
Demand becomes moresensitive to prices changesas time progresses, c.p.
We say demandis relativelyelastic.
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An Example: Demand for An Example: Demand for GasolineGasoline
If the price of gas increases from 80 If the price of gas increases from 80 Toman per Liter to 150 Toman per Toman per Liter to 150 Toman per Liter, how will consumers respond?Liter, how will consumers respond?
First:First:
Are we asking how consumers will Are we asking how consumers will respond over the next day, week, respond over the next day, week, month, year, etc. month, year, etc.
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It makes a difference!It makes a difference!
Demand for gas will be different for Demand for gas will be different for different time periodsdifferent time periods
The longer the time period considered, The longer the time period considered, the flatter the demand curve the flatter the demand curve becomes; or the becomes; or the more elastic more elastic it it becomes.becomes.
The The more responsive more responsive demand becomes demand becomes to changes in price!to changes in price!
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What Occured in the What Occured in the 1970’s?1970’s?
What was a simplified What was a simplified sequence of events sequence of events that occurred when that occurred when gas prices at the gas prices at the pump increased so pump increased so dramatically in the dramatically in the
1387?1387?
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The Sequence of Events:The Sequence of Events:
(1) People griped.(1) People griped.
(2) Car pools formed, and (2) Car pools formed, and bus usagebus usage
increased.increased.
(3) Big cars were replaced (3) Big cars were replaced with smallwith small
ones.ones.
(4) Some people moved (4) Some people moved closer to work.closer to work.
(5) New technology that (5) New technology that decreased fueldecreased fuel
consumption was consumption was developed.developed.
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What was the result of this What was the result of this sequence of events on sequence of events on Demand?Demand?
Price
Quantity demanded
$1.20
$2.20
Q1 Q0
In Short Run, the very large increasein gas price resulted in a very small decrease in consumption of gasoline.
D
Consumption of gas will not be veryresponsive to the increase in price.
We say demand is relatively inelastic
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As time progressed:As time progressed:As time progressed:As time progressed:
Price
Quantity demanded
$1.20
$2.20
Q1Q0
In Long Run, consumers have time tofind substitutes, and the very largeincrease in gas price will eventuallyresult in a significant decrease inconsumption of gasoline.
This of course assumes that consumers perceive the increasedprice of gas to be persistant, not just a temporary price increase.
D
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The Availability of The Availability of SubstitutesSubstitutes
D
Price
Quantity/unit time
If a commodity has FEW substitutes,demand for the commodity will tendto be more inelastic or less responsiveto price changes.
P0
P1
Q1 Q0
Demand curve will tend to have avery steep slope.
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D
Price
Qd/unit time
If a commodity has MANY substitutes,demand for the commodity will tendto be more elastic or more responsiveto price changes.
P0
P1
Q1 Q0
The Availability of The Availability of SubstitutesSubstitutes
Demand will tend to havea very flat slope.
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Proportion of the Consumers Proportion of the Consumers Budget a Good or Service Budget a Good or Service
RepresentsRepresents
D
Price
Qd/u.t.
Salt
$.50
$1.00
Q0Q1
If the price of SALT doubles, how muchwill this price increase affect the consumptionof salt?
Why?
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Proportion of the Consumers Proportion of the Consumers Budget a Good or Service Budget a Good or Service
RepresentsRepresentsThe less of a consumers budget a The less of a consumers budget a
commodity represents, the morecommodity represents, the moreinelasticinelastic the demand curve will the demand curve will
tend to be.tend to be.
The price of salt is such a small The price of salt is such a small percentage of our budgets, that percentage of our budgets, that consumption of salt will not be affected consumption of salt will not be affected very much by a price increase.very much by a price increase.
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Proportion of the Consumers Proportion of the Consumers Budget a Good or Service Budget a Good or Service
RepresentsRepresents
D
Price
Qd/u.t.
Automobile
$20,000
$40,000
Q0Q1
If the average price of an AUTO doubles,how much will this price increase affect theconsumption of Automobiles?
Why?
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Proportion of the Consumers Proportion of the Consumers Budget a Good or Service Budget a Good or Service
RepresentsRepresentsThe more of a consumers budget a The more of a consumers budget a
commodity represents, the morecommodity represents, the moreelasticelastic the demand curve will tend the demand curve will tend
to be.to be.
The price of an automobile is such a The price of an automobile is such a large percentage of our budgets, that large percentage of our budgets, that consumption of automobiles will be consumption of automobiles will be affected very much by a price increase.affected very much by a price increase.
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Automobile Prices:Automobile Prices:
Business Week reported Business Week reported on Feb. 7, 1994 that on Feb. 7, 1994 that the 1993 average the 1993 average price of a car wasprice of a car was
$18,100$18,100
This was a 69% This was a 69% increase from 1983. increase from 1983. What was the What was the average price of a car average price of a car in 1983?in 1983?
$10,710$10,710
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Real Price of a Car?Real Price of a Car?
Based on median Based on median household income:household income:
In 1983, it required 22 In 1983, it required 22 weeks of wages to weeks of wages to purchase a new car.purchase a new car.
In 1993, it required 26 In 1993, it required 26 weeks of wages to weeks of wages to purchase a new car.purchase a new car.
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Real Price of a Car?Real Price of a Car?
What did the real price of a car do What did the real price of a car do between 1983 and 1993 based on between 1983 and 1993 based on median household income?median household income?
It Went Up!It Went Up!
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References:References:
N.c.State university-College of Agriculture and Life science –N.c.State university-College of Agriculture and Life science –Dr. Dr. herman_sampsonherman_sampson