1 4-1: What Is Demand? □ Demand: the desire, ability, and willingness to buy a product. People generally tend to think of desire alone producing a demand, but all 3 facets must be present in order for demand to exist. For example, someone may desire and be willing to pay for a new car, but if the ability to pay is not present, neither is a demand for the new car. □ Demand is microeconomic concept. Microeconomics is the area of economics that deals with small units, such as individuals and firms. The study of microeconomics helps us understand and explain how prices are determined and how individual decisions are made. An Introduction to Demand □ One must have knowledge of demand in order to understand how a market economy works. It is also important for sound business planning. □ A demand schedule is a listing of the various quantities demanded for a particular product at all of the prices that might prevail in the market at a given time. o Example of a demand schedule: Price $5 $10 $15 $20 Quantity Demanded 20 15 10 5 □ The demand schedule can be graphically represented by a downward sloping line known as a demand curve. A demand curve shows the quantity demanded at each and every price that might prevail in a market. A demand curve may be created by plotting the information found in a demand schedule. o Example of a demand curve: 20 Price $5 $10 $15 $20 Quantity Demanded 20 15 10 5 15 Price 10 5 0 5 10 15 20 Quantity The Law of Demand □ Price and demand are inversely related. In other words, as price goes up, demand goes down and vice versa. This concept is known as the Law of Demand. Price is an obstacle that discourages consumers from 2 buying. Therefore, the higher the obstacle, the less people are willing to buy. People ordinarily buy more of a product at a lower price than at a high price. □ Economists often focus more on a market demand curve as compared to an individual demand curve. The market demand curve shows the quantities demanded by everyone who is interested in purchasing the given product. In order to calculate the market demand, one must add all of the information found on individual demand schedules for the given product. This information would then be graphed as previously described. o Example of a market demand curve: Person A Price Quantity Demanded $5 3 $10 2 $15 1 Person B Price Quantity Demanded $5 2 $10 1 $15 0 Market Demand Schedule Price Quantity Demanded $5 5 $10 3 $15 1 20 15 Price 10 5 0 1 2 3 4 5 Quantity Demand and Marginal Utility □ As discussed in chapter 1, utility refers to the amount of usefulness or satisfaction one gets from the use of a product. Marginal utility refers to the extra usefulness or satisfaction a person gets from acquiring or using one more unit of a product. For example, someone may get some level of utility from eating one piece of candy. Marginal utility would be the increase in utility one would experience when eating a second piece of candy. As more and more of a product is used, the principle of diminishing marginal utility becomes a factor. The principle of diminishing marginal utility states that the extra satisfaction one gets from using additional quantities of a product begins to diminish at a certain point. For example, the marginal utility one gets from eating additional pieces of candy would begin to decline as the person becomes full. People purchase items because they feel that the product is useful. As a person gets or use more and more of a product, it typically becomes less useful. Due to diminishing usefulness, people are often unwilling to pay as much for additional amounts of an item. This is the reason the demand curve is downward sloping. 3 4-2: Factors Affecting Demand □ Occasionally, things happen to change people’s willingness and ability to buy items. Such changes are usually of 2 types: a change in the quantity demanded, and a change in demand. Change in Quantity Demanded □ A change in the quantity demanded refers to a movement along the demand curve that shows a change in the quantity of the product purchased in response to a change in price. Gas is an item that is useful to examine for this principle. As gas prices go up, many people scale back on their amount of driving to reduce the amount they spend on gas. As prices drop, they may begin driving more. □ The gas example above illustrates the income effect. The income effect is the change in quantity demanded because of a change in price that alters the consumers’ real income. If prices go up, consumers pay more and have less real income to spend. The opposite is true if prices drop. □ Consumers also have a tendency to replace more costly item with less costly ones. This is known as the substitution effect. The substitution effect is the change in the quantity demanded because of a change in the relative price of a product. For example, if the price of CDs dropped, many people may choose to buy CDs as opposed to going to concerts. Since the CDs were substituted for concerts, a change in the quantity demanded for concerts would take place. □ A change in the quantity demanded always appears graphically as a movement along the demand curve because it is a direct result of a change in price. The demand curve itself does not shift; only the points on the curve shift as a result of a change in the quantity demanded. o Example of a change in the quantity demanded: 20 Price At a price of $15, the quantity demanded is 1. At a 15 price of $10, the quantity demanded is 3. This 10 represents the principle of a change in the quantity demanded. An increase or decrease in price alters the 5 0 quantity demanded. 1 2 3 4 5 Change in Demand □ In some cases, thing happen to make the demand curve itself shift. When this happens, a change in demand has taken place. A change in demand takes place because consumers are willing to buy different amounts of a product at the same price. The price does not change. The demand curve shifts to the right to indicate and increase and to the left to indicate a decrease. Demand can change 4 due to changes in consumer tastes, incomes, the price of related goods, expectations, and the number of consumers. o Consumer tastes vary. People tend to want products for various reasons, such as fashion trends, seasons, advertising, and so forth. If consumers want an item, they buy more of it at every price. If they don’t want an item, they buy less of it at every price. o As consumer incomes go up or down, so does their buying power. Consumer demand varies with income. o The price of related goods also impact demand. Substitutes are items that can be used in the place of others. For example, butter and margarine are substitutes. A rise in the price of a product would lower the demand for that product while increasing the demand for a substitute product. A decrease in the price of an item would increase the demand for it while reducing the demand for a substitute. Compliments are goods in which the use of one increases the use of the other. For example, hotdogs and ketchup. If the price of one item goes down, the demand for that product increases. So does the demand for the complimentary good(s). The opposite is also true. o Expectations refer to the way people think about the future. People often react based upon their expectations. Thus, expectations may drive purchases and impact demand. For example, if people expect gas prices to rise, they may purchase smaller vehicles in order to save money on gas. The demand for larger vehicles would decrease as a result of consumer expectations and purchases. o An increase or decrease in the number of consumers also change demand. Keeping in mind that the market demand is the sum of all individual demands, any shift in the number of consumers would impact the demand for a given product. □ A change in demand is always denoted by a change in the demand curve. D = Original demand Price D1 = an increase in demand D1 D2 Quantity D D2 = a decrease in demand 5 4-3: Elasticity of Demand □ Cause-and-effect relationships are important in the study of economics. One of the most important causeand-effect relationships is elasticity. Elasticity is a measure of responsiveness that tells how a dependent variable such as quantity responds to a variable such as price. Elasticity is a general concept that can be applied to income, the quantity of a product supplied, or to demand. Demand Elasticity □ Demand elasticity is the extent to which a change in the price causes a change in the quantity demanded. The concept of elasticity lets on know how sensitive consumers are to changes in price. □ Demand is elastic when a given change n price causes a relatively larger change in the quantity demanded. Demand is inelastic when a given change in price causes a relatively smaller change in the quantity demanded. Demand is unit elastic when a given change in price causes a proportional change in the quantity demanded. o Examples of elastic, inelastic, and unit elastic: Elastic Demand Price Inelastic Demand Price Price 2 1 0 2 2 1 1 0 1 2 Quantity □ As the price drops by one unit, the quantity demanded increases by more than one unit. Inelastic Demand 0 1 2 Quantity □ As the price drops one unit, the quantity demanded increases by less than one unit. 1 2 Quantity □ As the price drops by one unit, the quantity demanded increases by one unit. Total Expenditures Test □ The total expenditures test examines the impact of a price change on the total expenditures, or the amount that consumers spend on a product at a particular time. Total expenditures are found by multiplying the price of a product by the quantity demanded for any point along the demand curve. After multiplying the price and quantity demanded for at least 2 points along the demand curve, one can determine elasticity. If the two numbers are equal, the demand is unit elastic. If the numbers are inverse in the sense that price 6 goes down and expenditures go up, the demand is elastic. If the price and expenditures move in the same direction, then the demand is inelastic. o Examples of elastic, inelastic, and unit elastic: Price Quantity Demanded Total Expenditures Price Quantity Demanded Total Expenditures 2 4 8 2 3 6 4 2 8 4 1 4 Unit Elastic Elastic Price Quantity Demanded Total Expenditures 2 3 6 4 4 8 Inelastic □ Elasticity is important to study because it allows businesses to determine whether or not prices should be raised, lowered, or unchanged. Determinants of Elasticity □ By asking 3 basic questions, one can determine whether a product is elastic or inelastic. The questions are: 1. Can the purchase be delayed? 2. Are adequate substitutes available? 3. Does the purchase use a large portion of income? □ If the answer to 2 or more of the questions is yes, then the product is elastic. If the answer to 2 or more is no, then the product is inelastic.
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