Download - Demand · 2018-12-05 · measure the level of demand at each price, all we do is add up the total amount that is bought at each price. So when we are speaking of demand in economics

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Demand

DemandandSupplyarethetwowordsmostusedineconomicsandforgoodreason.SupplyandDemandaretheforcesthatmakemarketeconomieswork.Theydeterminethequan@tyofeachgoodproducedandthepricethatitissold.Ifyouwanttoknowhowaneventorpolicywillaffecttheeconomy,youmustthinkfirstabouthowitwillaffectsupplyanddemand.

Thisnoteintroducesthetheoryofdemand.LaterwewillseethatwhendemandisjoinedwithSupplytheyformwhatisknownasMarketEquilibrium.MarketEquilibriumdecidesthequan@tyandpriceofeachgoodsoldandinturnweseehowpricesallocatetheeconomy’sscarceresources.

Thequan@tydemandedofanygoodistheamountofthatgoodthatbuyersarewillingandabletopurchase.

Thewordableisveryimportant.Ineconomicswesaythatyouonlydemandsomethingatacertainpriceifyoubuythegoodatthatprice.Ifyouarewillingtopaythepricebeingaskedbutcannotaffordtopaythatprice,thenyoudon’tdemandit.Therefore,whenwearetryingtomeasurethelevelofdemandateachprice,allwedoisaddupthetotalamountthatisboughtateachprice.

Sowhenwearespeakingofdemandineconomicswearereferringtoeffec@vedemand.

Beforewelookfurtherintodemandwemakeourselvesawareofcertaineconomiclawsthathelpexplainconsumer’sbehaviourwhenbuyinggoods.(Rememberwecoveredeconomiclawsintheprevioushandout)

Allnormalgoodsobeythislaw.

Effec0veDemand:referstothedesireforgoodsandservicessupportedbythenecessarypurchasingpower.

LawofDemand:statesthatasthepriceofaproductrisesthequan@tydemandedwillfallandasthepriceofaproductfallssothequan@tydemandedwillrise.

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DemandSchedule

TheDemandCurve

TheDemandSchedule:showsthequan@tydemandedateachprice.

DemandScheduleforIce-CreamCones

Price Quan@ty

€0 12

€0.5 10

€1 8

€1.5 6

€2 4

€2.5 2

€3 0

TheDemandCurve:Thedemandcurve(whichgraphsthedemandschedule)showshowthequan@tydemandedofagoodvariesasitspricevaries.

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Price(€)

Quan@ty0

3

0.5

1

1.50

2

2.50

0 2 4 6 8 10 12

D1


Thereasonaperson’sdemandcurveforanormalgoodslopesdownwardisbecauseasthepriceofagoodfallstheconsumerbuysmoreofthischeapergood,becausethemarginalu@litypercentspentonthisgoodincreasesandtheconsumeraimstomaximisehis/hertotalu@lity.

Thedemandcurveoverleafshow’sanindividual’sdemandforicecreamcones.

However,ifweaddedtogethereachpersonsindividualdemandforanyproduct,wewouldgetwhatiscalledMarketDemand

IndividualDemand:isthequan@tyofagoodanindividualconsumerdemandsatdifferentprices.

MarketDemand:isthetotalquan@tyofagoodthatallconsumersdemandatdifferentprices.

DemandScheduleforIce-CreamCones

Price ConsumerA ConsumerB Market

€5 60 80 140

€10 40 60 100

€15 20 40 60

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P P P

Q Q Q

15

10

5

604020

ConsumerA’sDemandCurve ConsumerB’sDemandCurve MarketDemandCurve

15

10

5

15

10

5

806040 14010060

+ =

DA DB DM


Toderivethemarketdemandaddthequan0tydemandedbyeachindividualconsumerateachpricetocalculatetheoverallquan0ty

demandedbythemarketateachprice.

TheDemandcurveisagraphicalrepresenta@onoftheLAWOFDEMAND.Itshowsthataspricerises,demandfallsandviceversa.Allnormalgoodsobeythislaw.Butsomegoodsbreakthelawofdemandandtheyhavedifferentlyshapeddemandcurves,whichwewilllookatnow.

GoodsthatBreaktheLawofDemand

1) GoodsofOstenta0on(SnobGoods):Somecommodi@esbytheirexclusivenessorexpensivenessareaerac@vetosomebuyers.Ariseinpricemakesthemmoreexclusive,andtherefore,moreaerac@vetothosewiththeincomestopurchasethem.Afallinpricemayleadtoafallinquan@tydemandedastheymaynolongerappearasexclusivetotherichandares@lloutsidethepricerangeofthepoor.Theconsump@onofgoodsofostenta@onisknownasconspicuousconsump@on.

2) GoodsofExpecta0on:Ifprospec@vebuyersthinkthatpricesarelikelytobeevenhigherinthefuture,thecurrentlevelofdemandmaynotfallevenifpricesincreasee.g.ifapersonisconsideringbuyingahousethepossibilitythatpricesarelikelytobeevenhigherinthefuturewillprobablys@mulatedemandatcurrentprices.

3) GoodsofAddic0on:Inthecaseofthosegoodstowhichapersonbecomesaddictede.g.drugs,theynolongeractra@onally.Theybecomesoaddictedtothedrugthatinordertogetthesame'buzz'fromconsump@onofthedrug,demandforthecommoditymayincrease,evenwhenthepriceofthecommodityincreases.

4) GiffenGoods:Forcertainnecessi@esariseinpricecausesanincreaseindemandwhileafallinpricecausesafallindemand.Goodsoflowerqualitymakeupalargepartofthespendingoflowincomefamilies.Asthepricefalls,realincomesincreaseandfamiliesbuylessofthesegoodsandpurchasemore,beeerqualitygoods.Asthepricerisestheyhavelessincometospendonothertypesofgoodssotheytendtoincreasetheirdemandforthesegoods.

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Whenthepriceofanecessitythathasfewsubs@tutesrises,ata@mewhenincomesareextremelylow,thedemandforsuchnecessi@esmayalsorise.Thishappensasconsumerscutoutspendingonmoreexpensiveluxuriesandconsumemoreofthenecessity.

AnIrishexampleofaGiffengoodistheincreaseinthedemandforpotatoesastheirpriceroseduetoscarcityduringtheFamine.PeopleinIrelandspentmuchoftheirincomesonpotatoes(anecessitywithnosubs@tute).Aspotatoesbecamescarceandtheirpricerose,peoplecutoutspendingonothergoodssuchasmeet(aluxury)andallocatedmoremoneytopotatoes.Aspriceincreasedsodiddemand.

I.e.itreferstohowmuchstuffaeurowillbuy.Moreonthatlater.

Seethetableonthefollowingpageforthedemanddecisionoftheconsumerfollowinganincreaseinthepriceofpotatoes.

GiffenGoods:AGiffengoodisanecessitythathasfewsubs@tuteswhichrepresentsalargepor@onoftheexpenditureoflowincomefamilies.GiffengoodsreactabnormallytochangesinrealincomecausedbyapricechangeandassuchbreaktheLawofDemand.

MoneyIncome:Referstoincomeintermsofcurrency.E.g.€500perweek

RealIncome:Therealincomeofaconsumerreferstothepurchasingpowerofmoneyincome.

SpendingofLowIncomeFamilies

ConsumerIncome=€2

TheFamilybuys2goodsonly

Meat=€1.20Potatoes=€0.80

Goods Price Quan@ty Expenditure

Meat 1.2 1 €1.20

Potatoes €0.80 1 €0.80

€2

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Intheaboveexampleweseethateventhoughthepriceofpotatoesrose,thefamilyhadnochoicebuttobuymorepotatoes.Thatmeansthatforthisfamily,potatoesareaGiffenGood.Aspricesrose(theirrealincomefellasthepurchasingpowerofmoneyfell),thefamily’sdemandforpotatoesincreased.

Thereasonforthisunusualbehaviouristhatpotatoesare

1) ANecessity

2) WithFewSubs@tutes

3) Thatrepresentsalargepor@onoftheexpenditureofthislowincomefamily.

Whenyouthinkaboutit,thefamilyreallydidnothaveachoicebuttobuymorepotatoes.YoucanthinkofGiffenGoodsasnecessi@esthatpoorfamilieshavetobuy.Theyhavenochoicebuttobuythesenecessi@es.

SeethenextpagetoviewtheDemandCurveforgoodsthatbreaktheLawofDemand.

Remember,thegoodsthatbreaktheLawofDemandare

1) GoodsofOstenta@on

2) GoodsofExpecta@on

3) GoodsofAddic@on

4) GiffenGoods

SpendingofLowIncomeFamilies

ConsumerIncome=€2

TheFamilybuys2goodsonly

Meat=€1.20Potatoes=€1

Goods Price Quan@ty Expenditure

Meat 1.2 0 €0

Potatoes €1 2 €2

€2

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RegressiveDemandCurves

Sofarwehaveseendemandcurveswhentheyarenotmoving,buttherearemanyfactorswhichcausedemandtochange.Wewillnowhavealookatthefactorswhichcauseachangeindemand.

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Price(€)

Quan@ty

D1


ChangeinDemand

Thefollowingcauseachangeindemand

1) Changeinthepriceofthegooditself

2) PriceofRelatedGoods

3) GovernmentRegula@ons

4) Incomeoftheconsumer

5) ConsumerTastesorPreferences

6) Adver@sing

7) Expecta@onsregardingfutureprice

8) UnplannedFactors

Thefactorscanberepresentedbyademandfunc@on

1) PRICEOFTHEGOODITSELF:Generallyasthepriceofagoodfalls,consumerswillbuymoreofthatgood.Thisisbecauseconsumersaregelngbeeervaluefortheirmoney.Thiscausesadownwardmovementalongtheexis@ngdemandcurve.Asthepriceofagoodrisesconsumerswillbutlessofthatgood.Thisisbecauseconsumersaregelngworsevaluefortheirmoney.Thisincreaseinpricecausesamovementupwardsalongtheexis@ngdemandcurve.NOTE:Thechangeinthepriceofthegooditselfistheonlyfactorthatcausesamovementalongtheexis@ngdemandcurve.Allotherfactorscauseashiminthedemandcurve.

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D = f( , , G, Y, T, A, E, U) P1 P2

MovementUptheDemandCurve MovementDowntheDemandCurvePrice

Quan@ty

D1

P1

P2

Q1Q2

Price

Quan@ty

D1

P1

P2

Q1 Q2


2) PRICEOFRELATEDGOODS(Subs0tutesandComplements):Ifthepriceofacomplementarygoodrisesthenthedemandforthegoodinques@on(thisgood)fallsandviceversa.E.g.ifthepriceoftennisracquetsrisesthenthedemandfortennisballswillfall,aspeopletakeupothersports.Thiswillcauseaninwardshiminthedemandcurvefortennisballs.Ifthepriceofsubs@tutegoodrisesthedemandforthegoodinques@onrises.E.g.IfDazwashingpowderrisesinpricetherewillbeanoutwardshiminthedemandforPersil.

E.g.CokeandPepsi/DazandPersiletc.

3) GOVERNMENTREGULATIONS:Ifthegovernmentini@atesaprogramtocurtailconsump@onofapar@cularproductthenitmayaffectthedemandforthisgood.I.e.causinganinwardshiminthedemandcurve.E.g.ahealthcampaigntocurtailcigareeeconsump@on.

4) INCOMEOFTHECONSUMER:Fornormalgoods,asdisposableincomerises,thedemandforthemincreasescausinganoutwardshiminthedemandcurve.Ifincomefalls,thendemandforthesegoodswillfall,resul@nginaninwardshiminthedemandcurve.

5) CONSUMERTASTESORPREFERENCES:whenacommoditycomesintofashionorintoseason,thereisanincreaseinthequan@tydemandedateachprice.I.e.anoutwardshiminthedemandcurve.E.g.thedemandforshortsandt-shirtsrisescominguptosummer.Ahealthscarewillcausedemandtofallresul@nginaninwardshiminthedemandcurve.E.g.salmonellaineggs.

6) ADVERTISING:[email protected]@oninadver@singcausesthedemandcurveforagoodtoshiminwards.

7) EXPECTATIONSREGARDINGFUTUREPRICE:Ifaconsumerexpectsthatfuturepricesarelikelytobegreaterinthefuture,thismightcauseanincreaseindemandnowresul@nginanoutwardshiminthe

AMovementAlongtheDemandCurve:iscausedbyachangeinthesellingpriceofthegooditself,allotherthingsbeingequal.

ASUBSTITUTEGOOD:isagoodthatcanfulfillthesamefunc@onasthegoodinques@on.

COMPLEMENTARYGOODS:aregoodsthatareinjointdemand.

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demandcurve.Iffuturepricesareexpectedtofallthenthiswillcauseadecreaseindemandnowresul@nginaninwardshim.

8) UNPLANNEDFACTORS:Iftherewasasuddenheatwavethismightincreasethedemandforice-cream,thuscausinganoutwardshiminthedemandcurveforice-cream.

Frompoint2topoint8above,wehavelookedatthefactorsthatcause“ashiminthedemandcurve”.Remember,achangeinpricecausesamovementandachangeinanyotherfactorcausesashim.

Thereare2differenttypesofshimthatcanhappentoaDemandCurve.AnOutwardShimoranInwardShim.Wewilltakealookatagraphicalrepresenta@onofthemnow.

OutwardshiUintheDemandCurve

ShiUintheDemandCurve:Ifanyofthefactorsotherthanthepriceofthegooditselfchangethiswillresultinashiminthedemandcurve.

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Price

Quan@ty

D1

D2

P1

Q1 Q2


InwardShiUintheDemandCurve

Whenashiminthedemandcurveoccurs,thequan@tydemandedforthegoodateachpricechanges.Whenthereisaninwardshiminthedemandcurve,thenthequan@tydemandedforthatgoodateachpriceislessamertheshimthanitwasbeforetheshim.Whenthereisanoutwardshiminthedemandcurve,thenthequan@tydemandedforthatgoodateachpriceisgreateramertheshimthanitwasbeforetheshim.

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Price

Quan@ty

D1

D2

P1

Q1Q2


NormalGoods,InferiorGoodsandGiffenGoods

RememberNormalgoodsalsorespond“normally”tochangesinrealincome.

I.e.asincomerisesquan@tydemandedrisesandasincomefallsquan@tydemandedfalls.Thisisknownasaposi@veincomeeffect.Normalgoodshaveaposi@veincomeeffect.

Thatistheyrespondabnormallytochangesinrealincome.

I.e.asincomerisesquan@tydemandedfallsandasincomefallsquan@tydemandedrises.

GiffengoodsareinferiorgoodsbecauseallGiffengoodshaveanega@veincomeeffect(whichisthedefini@onofaninferiorgood).ThedifferencebetweenGiffengoodsandordinaryinferiorgoodsisthatGiffengoodsbreakthelawofdemand.

Ifpricesrisethenrealincomefallsandifpricesfallthenrealincomerises(assumingthatmoneyincomeremainsconstant)

Nowthatwehavealltheabovedefini@ons,wewillexplainwhynormalandinferiorgoodsobeythelawofdemandandwhyGiffengoodsbreakthelawofdemand.

FollowingaPricechangetherearetwoseparateeffectsontheconsumer.

1) TheSubs@tu@onEffect

2) TheIncomeEffect

WhenyouaddthesetwoeffectstogetheryougettheoverallPriceEffect.

NormalGoods:aregoodswithaposi@veincomeeffect.Demandforthesegoodsrisesasincomerisesandfallsasincomefalls

InferiorGoods:aregoodswithanega@veincomeeffect.

GiffenGoods:AGiffengoodisanecessitythathasfewsubs@tuteswhichrepresentsalargepor@onoftheexpenditureoflowincomefamilies.GiffengoodsreactabnormallytochangesinrealincomecausedbyapricechangeandassuchbreaktheLawofDemand.

RealIncome:Therealincomeofaconsumerreferstothepurchasingpowerofmoneyincome.

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ThePriceEffectisthetotaleffectondemandfollowingapricechange.Itistheaddi@onoftheIncomeEffectandtheSubs@tu@onEffect.

SUBSTITUTIONEFFECT+INCOMEEFFECT=PRICEEFFECT

TheSubs@tu@oneffectisalwaysposi@veforallgoods-Normal,InferiorandGiffen

Theconsumerwillalwaystendtobuymoreofarela@velycheapergood.ItistheSubs@tu@onEffectthatcausestheconsumertoalwaysbuymoreofarela@velygood.

However,followingapricefall,thegoodisnowrela@velycheaper,theconsumerexperiencesariseinrealincome.Thisistheincomeeffect.

Theincomeeffectcanbeeitherposi@[email protected]@veincomeeffectbutInferiorgoodsandGiffenGoodshaveanega@veincomeeffect.Lookattheexampleonthefollowingpage.

Assumeinthecaseofeachofthethreegoodsthatthereisafallinprice.Thenexaminetheeffectsofthispricereduc@ondemand.

THESUBSTITUTIONEFFECT:meansthatasthepriceofagoodfalls,consumerstendtobuymoreofitasthera@oofMarginalU@lity(MU)topriceincreases.Theconsumerwillswitchawayfromothergoodswhicharenowrela@velydearer.

THEINCOMEEFFECT:referstothechangeinconsumer’srealincomefollowingapricechange.I.e.ifpricesriserealincomesfallandifpricesfallrealincomesrise.

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TypeofGoodSubs@tu@on

Effect+ IncomeEffect = PriceEffect

(1)

Normal

Goods

+ + + = PQ

(2)

Inferior

Goods

+ > = PQ

(3)

Giffen

Goods

+ < = PQ


Goods(1)and(2)obeythelawofdemand.Inthecaseofgood(2)whichisinferiortheposi@vesubs@tu@oneffectoutweighsthenega@veincomeeffectandsothegoodhasaposi@vepriceeffect(obeysthelawofdemand,whichisthedefini@onofaposi@vepriceeffect).

However,inthecaseofgood(3)whichisbothinferiorandGiffen,thenega@veincomeeffectisstrongerthantheposi@vesubs@tu@oneffectcausinggood(3)tobreakthelawofdemand.

NOTE:Anega@veincomeeffectwilloccur(followingapricechange)whenaconsumersincreaseinrealincomeismoreimportantthanthefactthatthegoodhasbecomecheaper.Thatmeansthatastheconsumersincomerises,theirdemandforthisgoodfalls.

NowLet’sExplainwhatweareTalkingAbout

Nowthatwehavesomeideaaboutthedefini@ons,wewilltakeaslowerandmoreinvolvedlookateachofthestepsinvolvedinunderstandingtheconceptofconsumerchoice.

Whatwearetryingtodoistofindoutwhatchangeinconsumersbehaviourwilloccurwhenthepriceofagoodchanges.Willconsumersbuymoreorangesandlessappleswhenthepriceoforangesfalls?Willconsumersbuymorecarsandlessbusjourney’swhenthepriceofbusjourney’sfall?Someoftheanswersmightbesurprisingbutifyoufollowthestepsthatareoutlinedbelowyouwillbeabletoseehoweconomiststrytoexplainhowconsumersspendtheirmoneyandchangetheirspendinghabitsamerpriceschange.

[email protected],thistopicisverydifficult.InmyopinionitshouldnotbeontheLeavingCertcourseandismoredifficulttounderstandwithoutapriorknowledgeofwhatarecalledindifferencecurves.Toemphasishowdifficultthisstuffis,itisusuallylemun@lsecondyearincollege,itisseenasbeingtoodifficultforfirstyears!!!!!!.Secondly,itrarelycomesupandwhenitdoesitisofarela@velysimplenature.

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Withbothofthosepointsbeingmade,youshouldrealisethatitisquitestraightforwardtounderstandonceyoufollowthestepsthatIwilloutlinebelow,andintheunfortunateeventthatyoucannotunderstandthesesteps,youreallyonlyneedtoknowtheneteffectofapricechangeonthreetypesofgoods(NormalGoods,InferiorGoodsandGiffenGoods).Thesecanbelearnedoffandyieldthesamenumberofmarksifunderstandingthefollowingstepsalludesyou.

StepstofollowwhenAssessingConsumerChoice

Toanswerques@onsontheoverallpriceeffect,askyourselfthefollowingques@ons

1) Hasthegoodbecomerela@velycheaperorrela@velymoreexpensive?

2) Whatdoesthesubs@tu@oneffectsayhowthiswouldeffectdemand?

3) Haveyoubecomericherorpoorerinrealterms?

4) Doesthegoodhaveanega@veorposi@veincomeeffect?

5) Whatdoestheincomeeffectsayabouthowthiswouldeffectdemand?

6) Dotheseeffectsworkinthesamedirec@onoropposite.

7) Iftheyworkinoppositedirec@ons,askwhicheffectisbigger

Don’tbeworriedthatyoudon’tunderstandwhatanyofthesethingsmean,justbeawarethatwhenyouarefinishedreadingthenextfewpages,ifyoucannotunderstandthestepsoutlinedabove,thenyouneedtogooverthefollowingpagesagain.

LetsMakeaStart

Ineconomicswehavetwodifferentmeasuresofincome.

1) NominalIncome

2) RealIncome

E.g.€[email protected],week,month,yearetc.

NominalIncome:Referstoincomeintermsofcurrency.

REALINCOME:Therealincomeofaconsumerreferstothepurchasingpowerofmoneyincome.

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RealIncomedependsontwothings.Theamountofmoneyapersonreceives(theirnominalincome)andthepricesthathehastopayinordertobuygoodsandservices.NominalIncomeonlydependsontheamountofmoneyapersonreceives.

AnExampleofNominalandRealIncome

EXAMPLE1:

Inaverysimpleeconomy,wewillassumethatworkersearn€’sandthereisonlyonegoodproduced.BigMacs.

Aworkerearns€500perweekandthePriceofBigMacsis€5each.

Calculate

1) HisNominalIncome

2) HisRealIncome

Answer

1) HisNominalIncomeis€500

2) Hisrealincomeiscalculatedbydividinghismoneyincomebyprice€500÷€5=100BigMacs

Twothingsthatyoushouldnote.Firstly,nominalincomeisjusttheamountofmoneyreceivedbyaperson(consumer)anditismeasuredineuros.Secondly,RealincomeiscalculatedbydividingNominalIncomebyPriceandismeasuredintermsofunitsofgoodsandservicesaffordable.

EXAMPLE2:

Inaverysimpleeconomy,wewillassumethatworkersearn€’sandthereisonlyonegoodproduced.Milkshakes.

Aworkerearns€1,000perweekandthePriceofMilkshakesis€2each.

Calculate

1) HisNominalIncomeJonathanTraynor

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RealIncome =NominalIncome

Price


2) HisRealIncome

Answer

1) HisNominalIncomeis€1,000

2) Hisrealincomeiscalculatedbydividinghismoneyincomebyprice€1,000÷€2=500Milkshakes

Again,NominalIncomeismeasuredineurosandRealIncomeismeasuredinunitsofgoodsandservices.InthiscaseMilkshakes.

MoneyIncomeisonlyaffectedbytheamountofincomeyoureceive.

Ifyougetaraise,yourmoneyincomehasrisen.

Ifyougetawagereduc@on,yourmoneyincomehasfallen.

RealIncomedependsontwothings.

1) MoneyIncome

2) Prices

Ifyourmoneyincomerises(holdingpricesconstant),yourrealincomehasalsoincreased.Ifyourmoneyincomefalls(holdingpricesconstant),yourrealincomehasalsofallen.Ifyourmoneyincomestaysthesame,butpricesincrease,yourrealincomehasfallen.Ifyourmoneyincomestaysthesame,butpricesfall,yourrealincomehasrisen.

MoreExamples

Ineachofthefollowingcaseswelookatwhathappenstoaconsumersrealincome

1) Incomerisesandpricesstaythesame

2) Incomefallsandpricesstaythesame

3) Incomestaysthesameandpricesrise

4) Incomestaysthesameandpricesfall

5) Incomerisesandpricesfall

6) Incomefallsandpricesrise

7) Incomeriseandpricesrise

8) Incomefallsandpricesfall

Thereasonthatwecan’tsaywhathappenstoRealIncomeforthelasttwoisthatwedon‘tknowhowmuchincomeshavechangedandhowmuchpriceshavechanged.IfweknewbothofthesethingsthenwecouldsaywhattheeffectonRealIncomewas.

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RealIncomeRises

RealIncomeRises

RealIncomeRises

RealIncomeFalls

RealIncomeFalls

RealIncomeFalls

Can’tSay

Can’tSay


PriceEffects

FollowingaPricechangetherearetwoseparateeffectsontheconsumer.

1. TheSubs@tu@onEffect

2. TheIncomeEffect

WhenyouaddthesetwoeffectstogetheryougettheoverallPriceEffect.

ThePriceEffectisthetotaleffectondemandfollowingapricechange.Itistheaddi@onoftheIncomeEffectandtheSubs@tu@onEffect.

SUBSTITUTIONEFFECT+INCOMEEFFECT=PRICEEFFECT

TotrytoputthisinEnglish,allwearesayingisthatwhenthepriceofagoodchangesaconsumerhastomakeadecisiononhowtobestspendhismoneyinordertomaximisehisu@litywiththenewprices.Thelawofdemandsaysthatasthepricerises,consumersbuylessofagood.Thisistruebutinordertomaximisetheiru@lity,consumersmustspendalltheirmoney.

Therefore,ifconsumersbuylessofacertaingood,theys@llmighthavesomemoneylemandassuchmightbuymoreofothergoods.Soconsumersmightbuylessofthegoodwho’spricehasrisenbuttheymightalsobuymoreofothergoodswho’spricehasremainedthesame.

Thesubs@tu@oneffectisonewaythattheconsumersviewsthepricechange.Allitsaysisthatconsumerstendtobuymoreofarela0velycheapergood.

Theincomeeffectisanotherwaythattheconsumercanviewthepricechange.Theincomeeffectismorecomplexandassuchwewillwaitun@llatertodiscussit.

Iftheincomeeffectandthesubs@tu@onbothtelltheconsumertobuymoreofagoodasthepriceofthisgoodfalls(asinthecaseofanormalgood),thenthat’swhattheywilldo.

Ifthesubs@tu@oneffecttellstheconsumertobuymoreofthegoodasitspricefallsandtheincomeeffecttellstheconsumertobuylessofthe

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goodasthepriceofthegoodfalls,[email protected]@tu@oneffectisstrongerthantheincomeeffect,thentheconsumerwillbuymoreofthegoodasthepriceofthegoodfalls.Iftheincomeeffectisstrongerthanthesubs@tu@oneffect,thantheconsumerwillbuylessofthegoodasthepriceofthegoodfallsandchoosetobuyothergoodsinstead.

Wewilllookateachoftheseeffectsinturnstar@ngwiththesubs@tu@oneffect.

Subs0tu0onEffect

Allthesubs@tu@oneffectsmeansisthatconsumerswillbuymoreofrela@velycheapergoods.

TheSubs@tu@oneffectisalwaysposi@veforallgoods-Normal,InferiorandGiffen

Theconsumerwillalwaystendtobuymoreofarela@velycheapergood.ItistheSubs@tu@onEffectthatcausestheconsumertoalwaysbuymoreofarela@velycheapergood.

EXAMPLE

Wehavetwogoods,PepsiandPizza.ThepriceofPepsirises.

1) Whichgoodhasbecomerela@velycheaper

2) Whichgoodhasbecomerela@velydearer

3) Whatthesubs@tu@oneffectsayswillhappentothedemandforeachgood.

ANSWER

1) ThePizzahasbecomerela@velycheaper.Eventhoughthepriceofthepizzahasnotchanged,thepriceofpepsihasincreasedandassuchpizzahasbecomeRELATIVELYCHEAPERcomparedtopepsi.

2) Thepepsihasbecomerela@velydearer.Thisisbecausethepriceofpepsihasrisenandthepriceofpizzahasstayedthesame.

3) Thesubs@tu@oneffectsaysthatconsumerswillnowbuylesspepsiandnowbuymorepizza.

THESUBSTITUTIONEFFECT:meansthatasthepriceofagoodfalls,consumerstendtobuymoreofitasthera@oofMarginalU@lity(MU)topriceincreases.Theconsumerwillswitchawayfromothergoodswhicharenowrela@velydearer.

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Inordertoansweranyques@ononconsumerbehaviour,youmusttakeintoaccountboththesubs@[email protected]@tu@oneffectiseasy,itjustmeansyoubuymoreofrela@velycheapergoods.Asthepriceofagoodfalls,thesubs@[email protected],thesubs@tu@oneffecttellsyoutobuyless.

Theincomeeffectdependsonthetypeofgoodinques@on.Thatiswhatwewillturnouraeen@ontonow.

IncomeEffect

FollowingachangeinPrice,theconsumerexperiencesachangeinrealincome.Thisistheincomeeffect

Theincomeeffectcanbeeitherposi@veornega@ve.

Whatdoesitmeanifagoodhasaposi@veincomeeffect?

Itmeansthatconsumerswillbuymoreofagoodastheirrealincomerises.

Normalgoodshaveaposi@veincomeeffect.

WhatisaNormalGood?

[email protected]@veincomeeffectmeansthatyoubuymoreofthegoodasyourrealincomerisesandlessofthegoodasyourrealincomefalls

Whatdoesitmeanifagoodhasanega@veincomeeffect.

Itmeansthatyouhaveatendencytobuylessofthegoodasyourrealincomerises.

InferiorgoodsandGiffenGoodshaveanega@veincomeeffect.

Whatisaninferiorgood?

Itisagoodwithanega@veincomeeffect.Thismeansthatyoubuylessofthegoodasyourrealincomerisesandmoreofthegoodasyourrealincomefalls

THEINCOMEEFFECT:referstothechangeinconsumer’srealincomefollowingapricechange.I.e.ifpricesriserealincomesfallandifpricesfallrealincomesrise.

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ExamplesofIncomeEffectforNormalGoods

ForaNormalgood,anincreaseinrealincomewouldcauseanincreaseindemandforthegood.

Ineachofthefollowingcasesstatewhathappenstorealincomeandthenstatehowtheincomeeffectwouldaffectdemand.

1) ARiseinthepriceofPepsi

AsthepriceofPepsihasrisen,thismeansthattheconsumersrealincomehasfallen.TheconsumercannowaffordlessPepsi,andassuchispoorerinrealterms.

AsPepsiisaNormalGoodandyoubuylessnormalgoodsasyourrealincomefalls,theincomeeffectwouldbetobuylessPepsi.

2) AFallinthepriceofFosse]ssweets.

AsthepriceofFosseessweetshasfallen,thismeansthattheconsumersrealincomehasrisen.TheconsumercannowaffordmoreFosseessweets,andassuchisricherinrealterms.

AsFosseessweetsareanormalgoodandyoubuymorenormalgoodsasyourealincomerises,theincomeeffectwouldbetobuymoreFosseessweets.

3) AFallinthepriceofcars

Asthepriceofcarshasfallen,thismeansthattheconsumersrealincomehasrisen.Theconsumercannowaffordmorecars,andassuchisricherinrealterms.

Ascarsareanormalgoodandyoubuymorenormalgoodsasyourealincomerises,theincomeeffectwouldbetobuymorecars.

4) ARiseinthepriceofT.V.

AsthepriceofT.V.’shaverisen,thismeansthattheconsumersrealincomehasfallen.TheconsumercannowaffordlessT.V.’s,andassuchispoorerinrealterms.

AsT.V.’sareaNormalGoodandyoubuylessnormalgoodsasyourrealincomefalls,theincomeeffectwouldbetobuylessT.V.’s.

5) ARiseinthepriceofInsurance

AsthepriceofInsurancehasrisen,thismeansthattheconsumersrealincomehasfallen.Theconsumercannowaffordlessinsurance,andassuchispoorerinrealterms.

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AsinsuranceisaNormalGoodandyoubuylessnormalgoodsasyourrealincomefalls,theincomeeffectwouldbetobuylessinsurance.

ExamplesofIncomeEffectforInferiorGoods

Foraninferiorgood,anincreaseinrealincomecausesafallinthedemandforthegood.

Ineachofthefollowingcasesstatewhathappenstorealincomeandthenstatehowtheincomeeffectwouldaffectdemand.

1) ARiseinthePriceofPotatoes

AsthepriceofPotatoeshasrisen,thismeansthattheconsumersrealincomehasfallen.TheconsumercannowaffordlessPotatoes,andassuchispoorerinrealterms.

Aspotatoesareaninferiorgoodandyoubuymoreofaninferiorgoodasyourrealincomefalls,theincomeeffectwouldbetobuymorepotatoes.

2) AFallinthePriceofRice.

Asthepriceofricehasfallen,thismeansthattheconsumersrealincomehasrisen.Theconsumercannowaffordmorerice,andassuchisricherinrealterms.

Asriceisaninferiorgoodandyoubuylessofaninferiorgoodasyourrealincomerises,theincomeeffectwouldbetobuylessrice.

3) AFallinthePriceofBusJourney’s

Asthepriceofbusjourney’shasfallen,thismeansthattheconsumersrealincomehasrisen.Theconsumercannowaffordmorebusjourney’s,andassuchisricherinrealterms.

Asbusjourney’sareaninferiorgoodandyoubuylessofaninferiorgoodasyourrealincomerises,theincomeeffectwouldbetobuylessbusjourney’s.

4) ARiseinthePriceofmincedmeat

Asthepriceofmincedmeathasrisen,thismeansthattheconsumersrealincomehasfallen.Theconsumercannowaffordlessmincedmeat,andassuchispoorerinrealterms.

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Asmincedmeatisaninferiorgoodandyoubuymoreofaninferiorgoodasyourrealincomefalls,theincomeeffectwouldbetobuymoremincedmeat.

Wehavelookedatboththesubs@tu@oneffectandtheincomeeffectseparately.Inordertofindouthowmuchaconsumerwillincreaseordecreasethequan@tyofagoodthattheybuyfollowingapricechange,wemustcombinethesetwoeffects.

Inordertocombinethesetwoeffects,wegobacktothestepsthatwediscussedonpage16ofthisnotewhichhavebeenrepeatedonthenextpage.

StepstofollowwhenAssessingConsumerChoice

Toanswerques@onsontheoverallpriceeffect,askyourselfthefollowingques@ons







7) Iftheyworkinoppositedirec@ons,askwhicheffectisbigger

EXAMPLE

Explainhowindividuallythe

• Subs@tu@onEffect

• IncomeEffect

combinetogivetheoverallpriceeffectoneachofthefollowinggoods.

a) ThepriceofpepsifallsNormalGood

b) ThepriceofcarsriseNormalGood

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c) Thepriceofbusjourney’sriseInferiorGood

d) Thepriceofbusjourney’sfallsInferiorGood

e) ThepriceofpotatoesfallGiffenGood

f) ThepriceofricerisesGiffenGood

AnswertoQues0on(a)


Asthepriceofthegoodhasfallen,thegoodhasbecomerela@velycheaper


Thesubs@tu@oneffectsaysthatconsumersalwaysbuymoreofarela@velycheapergood.Asthisgoodhasbecomerela@velycheaper,thesubs@tu@oneffectsaysthatyouwillbuymoreofthisgood.


AstheGoodhasbecomerela@velycheaper,theconsumerisricherinrealtermsastheycanaffordtobuymoreofthegood.


Pepsiisanormalgoodandassuchhasaposi@veincomeeffect.


AsPepsiisanormalgoodwithaposi@veincomeeffect,thathasbecomecheaperinrealterms,theincomeeffectsaysthatyouwillbuymoreofthisgood.


Thesubs@tu@oneffectsaysbuymoreasithasbecomerela@velycheaperandtheincomeeffectsaysbuymoreasyouhavebecomericherinrealterms.Therefore,asthepricefallsyoubuymorepepsi.

Answertoques0on(b)


Asthepriceofthegoodhasrisen,thegoodhasbecomerela@velymoreexpensive

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Thesubs@tu@oneffectsaysthatconsumersalwaysbuymoreofarela@velycheapergood.Asthisgoodhasbecomerela@velydearer,thesubs@tu@oneffectsaysthatyouwillbuylessofthisgood.


AstheGoodhasbecomerela@velydearer,theconsumerispoorerinrealtermsastheycanaffordtobuylessofthegood.


Carsareanormalgoodandassuchhasaposi@veincomeeffect.


Ascarsareanormalgoodwithaposi@veincomeeffect,thathasbecomedearerinrealterms,theincomeeffectsaysthatyouwillbuylessofthisgood.


Thesubs@tu@oneffectsaysbuylessasithasbecomerela@velydearerandtheincomeeffectsaysbuylessasyouhavebecomepoorerinrealterms.Therefore,asthepricerisesyoubuyfewercars.

AnswertoQues0on(c)


Asthepriceofthegoodhasrisen,thegoodhasbecomerela@velymoreexpensive






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BusJourney’sareaninferiorgoodandassuchhasanega@veincomeeffect.


AsBusJourney’sareaninferiorgoodwithanega@veincomeeffect,thathasbecomedearerinrealterms,theincomeeffectsaysthatyouwillbuymoreofthisgood.


Thesubs@tu@oneffectsaysbuylessasithasbecomerela@velydearerandtheincomeeffectsaysbuymoreasyouhavebecomepoorerinrealterms.Therefore,wehavetoseewhetherthesubs@tu@oneffectortheincomeeffectisbigger,aseachistellingyoutododifferentthings.

7) Iftheyworkinoppositedirec@ons,askwhicheffectisbigger?

[email protected]@tu@oneffectisstrongerthantheincomeeffectandtheconsumerbuyslessbusjourneys.OrtheIncomeeffectisstrongerthanthesubs@tu@oneffectandtheconsumerbuysmorebusjourneys.Aswehavebeentoldintheques@onthatbusjourney’sareaninferiorgood,weknowthatthesubs@tu@oneffectisalwaysstrongerthantheincomeeffect(thatisonedefini@onofaninferiorgood).ForanInferiorGood,thesubs@[email protected],asthepriceofbusjourneysrise,peoplewillbuylessbusjourneysastheposi@vesubs@tu@oneffectisstrongerthanthenega@veincomeeffect.

AnswertoQues0on(d)


Asthepriceofthegoodhasfallen,thegoodhasbecomerela@velycheaper.





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BusJourney’sareaninferiorgoodandassuchhasanega@veincomeeffect.


AsBusJourney’sareaninferiorgoodwithanega@veincomeeffect,thathasbecomecheaperinrealterms,theincomeeffectsaysthatyouwillbuylessofthisgood.


Thesubs@tu@oneffectsaysbuymoreasithasbecomerela@velycheaperandtheincomeeffectsaysbuylessasyouhavebecomericherinrealterms.Therefore,wehavetoseewhetherthesubs@tu@oneffectortheincomeeffectisbigger,aseachistellingyoutododifferentthings.


[email protected]@tu@oneffectisstrongerthantheincomeeffectandtheconsumerbuysmorebusjourneys.OrtheIncomeeffectisstrongerthanthesubs@tu@oneffectandtheconsumerbuyslessbusjourneys.Aswehavebeentoldintheques@onthatbusjourney’sareaninferiorgood,weknowthatthesubs@tu@oneffectisalwaysstrongerthantheincomeeffect(thatisonedefini@onofaninferiorgood).ForanInferiorGood,thesubs@[email protected],asthepriceofbusjourneysfall,peoplewillbuymorebusjourneysastheposi@vesubs@tu@oneffectisstrongerthanthenega@veincomeeffect.

AnswertoQues0on(e)


Asthepriceofthegoodhasfallen,thegoodhasbecomerela@velycheaper.




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Potatoesareagiffengoodandassuchhasanega@veincomeeffect.


AsPotatoesareagiffengoodwithanega@veincomeeffect,thathasbecomecheaperinrealterms,theincomeeffectsaysthatyouwillbuylessofthisgood.


Thesubs@tu@oneffectsaysbuymoreasithasbecomerela@velycheaperandtheincomeeffectsaysbuylessasyouhavebecomericherinrealterms.Therefore,wehavetoseewhetherthesubs@tu@oneffectortheincomeeffectisbigger,aseachistellingyoutododifferentthings.


[email protected]@tu@oneffectisstrongerthantheincomeeffectandtheconsumerbuysmorepotatoes.OrtheIncomeeffectisstrongerthanthesubs@tu@oneffectandtheconsumerbuyslesspotatoes.Wehavebeentoldintheques@onthatpotatoesareagiffengood,weknowthattheincomeeffectisalwaysstrongerthanthesubs@tu@oneffect(thatisonedefini@onofangiffengood).ForaGiffenGood,theincomeeffectisalwaysstrongerthanthesubs@[email protected],asthepriceofpotatoesfall,peoplewillbuylesspotatoesastheposi@vesubs@tu@oneffectisweakerthanthenega@veincomeeffect.

AnswertoQues0on(f)


Asthepriceofthegoodhasrisen,thegoodhasbecomerela@velydearer.




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Riceisagiffengoodandassuchhasanega@veincomeeffect.


Asriceisagiffengoodwithanega@veincomeeffect,thathasbecomedearerinrealterms,theincomeeffectsaysthatyouwillbuymoreofthisgood.


Thesubs@tu@oneffectsaysbuylessasithasbecomerela@velydearerandtheincomeeffectsaysbuymoreasyouhavebecomepoorerinrealterms.Therefore,wehavetoseewhetherthesubs@tu@oneffectortheincomeeffectisbigger,aseachistellingyoutododifferentthings.


[email protected]@tu@oneffectisstrongerthantheincomeeffectandtheconsumerbuyslessrice.OrtheIncomeeffectisstrongerthanthesubs@[email protected]@onthatriceisagiffengood,weknowthattheincomeeffectisalwaysstrongerthanthesubs@tu@oneffect(thatisonedefini@onofangiffengood).ForaGiffenGood,theincomeeffectisalwaysstrongerthanthesubs@[email protected],asthepriceofricerises,peoplewillbuymorepotatoesastheposi@vesubs@tu@oneffectisweakerthanthenega@veincomeeffect.

Summary

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TypeofGoodSubs@tu@on

Effect+ IncomeEffect = PriceEffect

(1)

Normal

Goods

+ + + = PQ

(1)

Normal

Goods

+ + + = PQ

(2)

Inferior

Goods

+ > - = PQ

(2)

Inferior

Goods

+ > - = PQ

(3)

Giffen

Goods

+ < - = PQ

(3)

Giffen

Goods

+ < - = PQ

Download - Demand · 2018-12-05 · measure the level of demand at each price, all we do is add up the total amount that is bought at each price. So when we are speaking of demand in economics

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