CHAPTER 4

DEMAND

Defining Demand• Market : exchange between buyers and

sellers of goods and services.

• Supply : the amount of goods and services that sellers are willing to sell at various prices at particular times.

• Demand : the amount of goods and services consumers are willing to buy at various prices at particular times.

LAW OF DEMAND• If all other things are constant, the higher the price of a product or service, the less of it people are willing to buy .

Law of Demand

Therefore if the price of a good goes up

then the Quantity demanded goes down

holding other things constant!!!

Quantity demanded (Qd)

• amount of good or service• unit of measure

• per unit of time

• “2 bottles of water per day”

Why Demand rises & falls ?

Real Income Effect - What people can actually buy

- higher price makes you feel poorer- value of income based on prices

Substitution Effect -higher price on one good will cause a

replacement with similar goods.

Demand describe in 2 ways:

• Demand schedule• The relationship between the

Quantity demanded at each price

• Demand curve• a graph of demand schedule• Example: bottles of water per day

Demand Schedule

P QdPrice = $/bottle

Qd = bottles/day

$2.00 0$1.50 1

$1.00 2$.50 3

Demand curveP

Qd

0 1 2 3 4

2

1.5

1

.5D

• Individual Demand• demand curve for 1 buyer

• Market Demand**• Sum of all individual buyers• Add up individual Qd for

each price

Changes in Demand• recall our assumption

• hold other things constant• allow only price to change

• but what if other factors do change?• change in demand• shift to a new demand curve

Causes of shifts in demand

• Average income

• Population

• Complements

• Substitutes

• Personal Preferences

• Special Influences

• Future Expectations

Increase in demand• increase in Qd at every price• demand curve shifts to the

right

P

Qd0 1 2 3 4

2

1.5

1

.5 DD’

Decrease in demand• decrease in Qd at every

price• demand curve shifts to the

left

P

Qd

DD’’

Normal Goodsan increase in income will increase demand• Examples: Ipods, bottled water

Inferior Goodsan increase in income will

decrease the demand

• examples: Ramen noodles, Dollar store

Prices of related goods• What are related goods?

• substitutes

e.g. Snapple, Coke

• complements

goods consumed

with soft drinks

e.g. chips, popcorn

SubstitutesIf price of Snapple rises,

• people switch to water• increase in demand for water

If price of Snapple falls,• people switch from water to Snapple• decrease in demand for water

ComplementsIf price of chips rises

• eat fewer chips, so consume less

soft drinks• demand for soft drinks falls

$ price

DEMAND

Preferences• what we want to buy?• Change in our likes/dislikes

• Skinny jeans? • Tattoos?

• Change in technology• Flash drives?• Ipods?

Important!!• Change in demand

-- occurs when other factors change

-- shift to a new demand curve

• Change in demand• NOT caused by change in price of the

good

Change in DemandP

Qd

DD

• Change in quantity demanded-- occurs when prices

change -- movement along existing demand curve

Change in QdP

Qd

D

Law of Diminishing Marginal Utility

Diminishing : shrinking, growing smaller

Utility : usefulness, amount of satisfaction

Marginal utility : extra usefulness you get from using more of a product or service

• As people use more of a product or service, the satisfaction they get from their additional purchases declines.

Elasticity of Demand

Elastic

Vs.

InelasticQuickTime™ and a

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Large change

Small or No change

Effects of Elasticity

Elastic• More substitutes• Large % of real income• High competition

Inelastic• Few substitutes• Small % of real income• Low competition

• Price elasticity reveals the responsiveness of the amount purchased to a change in price.

Elasticity of Demand

Price Elasticityof demand = =

% Q

% P

% Change in quantity demanded% Change in Price

- or put simply -)()(

)()(

1010

1010

PPPP

QQQQ

+−+−

(c)

Price

Quantity/time

(b)

Price

Quantity/time

(a)

Price

Quantity/time

Demand curve of unitary elasticity

Mythicaldemandcurve

Demandfor Cigarettes

• Perfectly inelastic: Despite an increase in price, consumers still purchase the same amount. In fact, the substitution and income effects prevent this from happening in the real world.

• Relatively inelastic: A percent increase in price results in a smaller % reduction in sales. The demand for cigarettes has been estimated to be highly inelastic.

• Unitary elasticity: The % change in quantity demanded is equal to the % change in price. A curve of decreasing slope results. Sales revenue (price times quantity sold) is constant.

Elasticity of Demand

(e)

Price

Quantity/time

(d)

Price

Quantity/time

Demand for Farmer Jones’s wheat

Demandfor Apples

• Relatively elastic: A percent increase in price leads to a larger % reduction in purchases. When good substitutes are available for a product (as is the case for apples), the amount purchased will be highly sensitive to a change in price.

• Perfectly elastic: Consumers will buy all of Farmer Jones’s wheat at the market price, but none will be sold above the market price.

Elasticity of Demand

DQuantity Demanded

/Time

1

2

100 110

Price ($)

Elasticity (– ) 0.14=

= ( - ) 0.14

)()(

)()(

1010

1010

PPPP

QQQQ

+−+−

Recall -

• With this straight-line (constant-slope) demand curve, demand varies across a range of prices.

• Using the equation for elasticity from before, the formula for arc elasticity shows that, when price rises from $1 to $2 . . . and quantity demanded falls from 110 to 100 . . . the elasticity for that region of the demand curve is ( - .14 ) (inelastic).

(110 - 100) (110 + 100)

($1 - $2) ($1 + $2)

Elasticity of Demand

DQuantity Demanded

/Time

Price ($)

Elasticity (– ) 7. 0=

= ( - ) 7.0

)()(

)()(

1010

1010

PPPP

QQQQ

+−+−

Recall -

• A price increase of the same magnitude (but a smaller %) from $10 to $11 . . . leads to a decline in quantity demanded from 20 to 10. Even though the change in price here was smaller than before (as a %) the same change in quantity demanded occurred.

(20 - 10) (20 + 10)

($10 - $11) ($10 + $11)

Elasticity of Demand

• Using the same equation to calculate elasticity as before, the elasticity amounts to - 7.0 (greater than - .14 from before).

• Thus the price-elasticity of a straight-line demand curve increases as price rises.

10

11

10 20

• Availability of substitutes

Determinants of Price Elasticity of Demand

When good substitutes for a product are available, a rise in price induces many consumers to switch to other products causing demand to be elastic.

Share of total budget expended on productAs the share of the total budget expended on the product rises, demand is more elastic.

25

$1.50

(a) Ballpoint pens per week (in thousands)

$1.00

100

D

90

$1.50

(b) Cigarette packs per week (in millions)

$1.00

100

D

PricePrice

• As the price of ballpoint pens (a) rises from $1.00 to $1.50 (a 50% increase in price) . . . quantity demanded plunges from 100,000 to 25,000 (a 75% decrease in quantity demanded).

• The % reduction in quantity demanded is larger than the % increase in price, thus the demand for ballpoint pens is elastic.• As the price of cigarettes (b) rises from $1.00 to $1.50 (a 50% increase in price) . . . quantity demanded plunges from 100 mil. to 90 mil. (a 10% decrease in quantity demanded).• The % reduction in quantity demanded is smaller than the % increase in price, thus the demand for cigarettes is inelastic.

Elastic and Inelastic Demand

• If the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run.

Time and Demand Elasticity

Thus, the demand for most products will be more elastic in the long run than in the short run.This relationship is often referred to as the second law of demand.

Elasticity of Demand

0.9 1.2

0.9

1.1

1.1 0.9 1.2 1.2

2.3 4.0 2.4 2.8

1.2–1.5 4.0 4.6

0.1 0.1 0.1 0.1 0.2 0.7 0.1

0.5

0.25 0.5

0.45

0.4 0.6 0.6 0.2

INELASTIC

Salt Matches Toothpicks Airline travel (short run) Gasoline (short run) Gasoline (long run) Residential natural gas (short run) Residential natural gas (long run) Coffee Fish (cod), consumed at home Tobacco products (short run)

Legal services (short run) Physician services Taxi (short run) Automobiles (long run)

APPROXIMATELY UNITARY ELASTICITY

Movies Housing, owner occupied (long run) Shellfish (consumed at home) Oysters (consumed at home) Private education Tires (short run

Tires (long run) Radio and television receivers

ELASTIC

Restaurant meals Foreign travel (long run) Airline travel (long run) Fresh green peas Automobiles (short run Chevrolet automobiles Fresh tomatoes

• Can you explain why the demand for some goods is highly inelastic while that for others is elastic.

Make a list of 5 items you buy regularly.

Think of any substitutes and complements for the items.

Decide whether they are elastic or

inelastic.

Explain why.