DemandDemandBy. Janine Hepler

What is Demand?What is Demand?

The desire to own something & the ability to pay for it

Represents whole range of quantities

The Law of DemandThe Law of Demand

Consumers will buy more of a good when its price is lower

Consumers will buy less of a good when its price is higher

Quantity demanded is higher at lower prices & vice versa◦ Inverse Relationship

Representing DemandRepresenting Demand

Demand Schedule Demand Curve

List/table showing how much of a product would be purchased at specific prices

Graphic illustration showing the relationship b/t price & quantity demanded at ALL prices

Shows every possible price/QD combination

*Demand schedules are used to create demand curves (more informative)

*Demand Curve= Downward-Sloping

Quantity Demanded: DefinedQuantity Demanded: Defined

How much of an item a person demands at specific prices

Change in quantity demanded can only be caused by a change in a product’s price

The Substitution EffectThe Substitution Effect

When prices change (decrease/increase), consumers will change the mix of products that they buy

As the price of a product goes up…◦Buy other goods to replace

THAT product

As the price of a product goes down…Buy THAT product to

replace other goods

Substitute & Complementary Substitute & Complementary GoodsGoods

Substitute Complementary

Products that can replace each other◦ Butter & Margarine◦ Taxis & Buses◦ Beef & Chicken

Products that are used together◦ Peanut Butter & Jelly◦ Ketchup & Mustard◦ Cars & Car Washes◦ I-pods & I-Tunes

Name 3 goods that could be complements to hamburgers.

Name 3 goods that could be substitutes for movie tickets.

The Substitution Effect at The Substitution Effect at WorkWork

Price of product ◦Buy MORE substitute goods◦Buy LESS complementary goods

Price of product◦Buy LESS substitute goods◦Buy MORE complementary goods

Income Affects What You BuyIncome Affects What You Buy

Normal Goods Inferior Goods

Things that you have always liked & bought regardless of income

Consumers will demand more normal goods as their income increases

Things that you buy only b/c you were unable to afford something else

Consumers will demand less inferior goods as their income increases

The Income EffectThe Income Effect

The change in consumption that results when a price increase causes real income to decline

Increasing/Decreasing prices changes the buying power of income◦ Income stays the same

The higher the price of pizza,

the fewer slices people will buy

Eating salad or tacos instead of pizza when the price of

pizza increases

Buying fewer slices of pizza when rising

prices reduce real income

Table that lists quantities of a

good that a person will buy at each price

Goods that you will always buy regardless of your income

Graphical representation of a demand schedule for

the entire market

Changes in DemandShifting the Demand Curve

Ceteris ParibusCeteris Paribus

Latin phrase, “all other things held constant”

Demand schedules & curves are accurate taking into consideration price ONLY

Changes in DemandChanges in Demand

Sometimes increases/decreases in demand aren’t connected to price

When ceteris paribus is dropped, we allow other factors to change

Determinants of DemandDeterminants of Demand

IncomePopulationDemographicsConsumer Tastes & AdvertisingPrices of Related GoodsConsumer Expectations

CHANGE IN QUANTITY DEMANDED CHANGE IN DEMAND

Change in the amount of a product at specific prices

Only brought on by a change in price

Movement along the demand curve

At every price, consumers demand a different quantity than before

Caused by ALL factors other than price

Shifts entire demand curve to the left or right

Graphing the Changes ( )Graphing the Changes ( )

CHANGE IN QUANTITY DEMANDED CHANGE IN DEMAND

Shift RIGHT—Rise (Increase in Demand)Shift LEFT—Loss (Decrease in Demand)

Factors That Influence DemandDeterminants of Demand

IncomeIncome

As income increases…Buy more normal goodsBuy less inferior goods (if any at all)

As income decreases…Buy less normal goodsBuy more inferior goods

How do these changes affect the demand curve?

Consumer ExpectationsConsumer Expectations

Current demand for a good is positively related to its expected future price

If you expect prices to Buy now

If you expect prices toBuy later

How would the demand curve for these items be affected in the event of a natural disaster warning?

PopulationPopulation

Population changes have a strong effect on certain goods

Example: U.S. Baby Boom

Baby clothes, food, books on baby care

HousingSchools & CollegesRetirement plans,

medical care, RVs

DemographicsDemographics

Statistical characteristics of populations

Age, race, gender, occupation, income level, etc.

As the purchasing power of groups grow…

Firms devote more resources to meeting their demands

Consumer Tastes & Consumer Tastes & AdvertisingAdvertising

Social trends, advertising, & the influence of the media affect demand

Companies spend $ on advertising in hopes of increasing demand

Conspicuous Consumption◦ “Keeping up with the

Jones”

Prices of Related GoodsPrices of Related Goods

The demand curve for one good can also shift in response to a change in demand for another good

As product pricesBuy more substitute goodsBuy less complementary goods

As product pricesBuy less substitute goodsBuy more complementary goods

Why would McDonald’s or any other business offer free promotions to customers?

Causes of a Shift

in the Demand Curve

UtilityUtility

The Demand Curve & LifeThe Demand Curve & Life

The Demand Curve is simply a reflection of what makes us happy

The happier something makes us, the more we would be willing to exchange for it◦Higher demand

UtilityUtility

There is no obvious measure of happiness

Goosebumps, smiles, giggles, satisfaction points

Economists measure happiness in terms of utility◦Measured in “utils”

SubjectivitySubjectivity

Utility is subjective & the result of personal tastes & preferences

◦Some people like sushi, some people like fish cooked

◦Some people like to shoot animals with cameras, others prefer rifles

Consumer SatisfactionConsumer Satisfaction

UtilitySatisfaction from consuming a product

Marginal Utilitythe amount of satisfaction from 1 more unit of a product

Diminishing Marginal UtilityIdea that as additional units of a product are consumed during a given period of time, the additional satisfaction decreases

Marginal UtilityMarginal Utility

A dollar will get you either 1 can of soup or a can of soda◦ The Average American purchases

19 cans of soda & only 1 can of soup per week

The marginal utility for a typical consumer for refrigerators starts high & plummets after a quantity of 1◦ This is why there aren’t buy-one-

get-one free sales—marginal utility doesn’t warrant the promotion

Diminishing Marginal UtilityDiminishing Marginal Utility

Each additional unit of a good or service consumed provides less happiness (fewer utils)

Negative slope◦The height of the curve

indicates the most that consumers would be willing to pay for 1 more unit of a product

Diminishing Marginal UtilityDiminishing Marginal Utility

Consider This:The average U.S. citizen consumes

◦ 49.2 gallons of soft drinks◦ 67 lbs. of poultry◦ 12,406 kilowatt-hours of

electricity

But have you ever heard of anyone with more than 1 subscription to the same newspaper?

Unless you love paper mâché or own a new puppy—the marginal utility of a 2nd newspaper is miniscule

Elasticity of DemandElasticity of DemandThe Effect of Price Changes

Elasticity of DemandElasticity of Demand

Measures how much buyers will cut back/increase demand when prices change

Are there products you would continue to buy, even if the price were to change drastically?

Defining ElasticityDefining Elasticity

ELASTIC INELASTIC

Demand sensitive (responsive) to price changes

Ex.) If you would buy less of a good after a small price increase

Demand that is NOT sensitive (responsive) to price changes

Ex.) If you would buy the same amount (or just a little less) after a large price increase

Elastic Demand•Demand is sensitive to price changes

•Substitutes are available

•Seen as a luxury

•Substitutes can be found long term

Inelastic Demand•Demand is NOT sensitive to price changes

•Substitutes are NOT readily available

•Seen as a necessity

•No time to react to price changes in the short term

PROM

Calculating ElasticityCalculating Elasticity

Percentage Change in Quantity Demanded

Percentage Change in Price

DIVIDED BY

Interpreting the ResultsInterpreting the Results

The Law of Demand implies that the result will always be negative◦ An increase in the price

should decrease the quantity demanded & vice versa

Less than 1 = Inelastic◦ Keep buying regardless of

price

More than 1= Elastic◦ Price affects buying

Unitary ElasticUnitary Elastic

If elasticity is exactly equal to 1, then it is unitary elasticunitary elastic

Ex.) Suppose the elasticity for a magazine at $2 is unitary—

When the price rises by 50% to $3, exactly ½ as many copies will be sold as before

Factors that Determine Elasticity

Price RangePrice Range

Elasticity of demand varies at every price level

Availability of SubstitutesAvailability of Substitutes

Lack of substitutes can make demand inelastic◦Life-saving Medicine◦Addictions

A wide choice of substitutes can make demand elastic◦Orange Juice◦Jeans

Perfectly Inelastic Demand Curve

Perfectly Elastic Demand Curve

Relative ImportanceRelative Importance

Depending on how much of your budget you spend on a good, a price increase will make you prioritize your budget

HousingColored Pencils

Necessity vs. LuxuryNecessity vs. Luxury

NecessityGood people will always buy, even when the price increases

LuxuryItem that can be reduced/removed from a budget when its price increases

Change Over TimeChange Over Time

Demand sometimes becomes more elastic over time

Inelastic in the short term

People can eventually find substitutes that allow adjustments to what they buy

Elastic Demand Inelastic Demand

• Demand Sensitive• Substitutes

available• More of income

spent on good• Seen as a luxury• Substitutes can be

found in the long term

• Demand NOT sensitive

• Substitutes NOT available

• Less of income spent on good

• Seen as a necessity• No time to react in

the short term

Elasticity & Total RevenueElasticity & Total Revenue

The elasticity of demand determines how a change in price will affect a firm’s total revenue◦AKA income

Total Revenue=Price x Quantity Sold

Elasticity & Total RevenueElasticity & Total Revenue

Elastic Demand Inelastic Demand

As the price is lowered, total revenue rises

As the price is raised, total revenue falls

As the price is lowered, total revenue falls

As the price is raised, total revenue risesKnowing whether a firm’s

product demand is elastic or inelastic is helpful in making

wise pricing decisions & estimating revenue