1 module 2 market mechanism demand. 2 demand understand the difference between demand and quantity...

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Module 2Module 2Module 2Module 2Market Mechanism Market Mechanism

DemandDemandMarket Mechanism Market Mechanism

DemandDemand

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Understand the difference between demand demand and quantity demanded.and quantity demanded.

ObjectivesObjectivesObjectivesObjectives

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Understand the difference between demand and demand and quantity demanded.quantity demanded.

Define and explain the law of demand,law of demand, and the tworeasons why a demand curve usually slopes downwards.


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Understand the difference between demand demand and quantity demanded.quantity demanded.

Define and explain the law of demand,law of demand, and the two reasons why a demand curve usually slopes downwards.

Understand the difference between a change in change in demand demand and a change in quantity demanded.change in quantity demanded.


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Understand the difference between demand demand and quantity demanded.quantity demanded.

Define and explain the law of demand,law of demand, and the two reasons why a demand curve usually slopes downwards.

Understand the difference between a change in change in demand demand and a change in quantity demanded.change in quantity demanded.

Understand what causes demand to shift.shift.


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Understand the difference between demand Understand the difference between demand and quantity demandedand quantity demandedUnderstand the difference between demand Understand the difference between demand and quantity demandedand quantity demanded

A demand curvedemand curve shows quantities demanded by a consumer at various prices.

Objective 1Objective 1Objective 1Objective 1

Objective 1: ... demand and quantity demandedObjective 1: ... demand and quantity demanded

A demand curvedemand curve shows quantities demanded by a consumer at various prices.

Price Price per cup per cup

($)($)

Quantity Quantity DemandedDemanded

(cups of coffee)(cups of coffee)

1.00 10

2.00 9

3.00 8

4.00 7

5.00 6

6.00 5

7.00 4

8.00 3

9.00 2

10.00 1

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Quantity demandedQuantity demanded is the amount of a product that a consumer is willing and able to purchase at a particularparticular price.


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Demand versus Quantity Demanded:Demand versus Quantity Demanded: Demand refers to the entire curve while quantity demanded is associated with a point on the curve.

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Define and explain the law of demand … Define and explain the law of demand …

Objective 2Objective 2

A demand curvedemand curve is drawn with a downward-slope to indicate an inverseinverse (negative) relationship between priceprice and quantity quantity demanded.demanded.

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Define and explain the law of demand …Define and explain the law of demand …Define and explain the law of demand …Define and explain the law of demand …

The Law of DemandLaw of Demand states that holding everything else constant, when the priceprice of a product falls, the quantity quantity demandeddemanded of the product will increase and when the price of a product rises, the quantity demanded of the product will decrease.


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Define and explain the law of demand …Define and explain the law of demand …Define and explain the law of demand …Define and explain the law of demand …

The Law of Demand Law of Demand is explained by two effects of a price change.

When the price of a good changes, there are two effects: (i) the substitution effectsubstitution effect of a price change, and (ii) the income effectincome effect of a price change.


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The Law of Demand is explained by the incomeincome and substitutionsubstitution effects of a price change.

Objective 2: … the two reasons why a demand Objective 2: … the two reasons why a demand curve slopes downwardscurve slopes downwards

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The Law of DemandLaw of Demand is explained by the income and substitution effects of a price change.

The substitution effectsubstitution effect is the change in quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods that are substitutes.

Objective 2: … the two reasons why a demand Objective 2: … the two reasons why a demand curve slopes downwardscurve slopes downwards Objective 2: … the two reasons why a demand Objective 2: … the two reasons why a demand curve slopes downwardscurve slopes downwards

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The Law of DemandLaw of Demand is explained by the income and substitution effects of a price change.

The substitution effectsubstitution effect is the change in quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods that are substitutes.

The income effectincome effect is the change in the quantity demanded of a good that results from the effect of a change in the good’s price on a consumer’s purchasing power.


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Do Not Confuse the substitution effectsubstitution effect of a price change with the change in the price of change in the price of a substitutea substitute good.


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Do Not Confuse the substitution effectsubstitution effect of a price change with the change in the price of change in the price of a substitutea substitute good.


The substitution effect of a price changesubstitution effect of a price change explains a movement along the curve. Specifically, we’re asking the question: Now that the price of good X has gone up, it is more expensive relative to other goods that can substitute for X and so will this “relative price effect” change the amount of X that I want to buy?

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Do Not Confuse the income effect of a priceincome effect of a price changechange with the effect of a change in income.

Objective 2…. the two reasons why a demand curve Objective 2…. the two reasons why a demand curve slopes downwards.slopes downwards. Objective 2…. the two reasons why a demand curve Objective 2…. the two reasons why a demand curve slopes downwards.slopes downwards.

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Do Not Confuse the income effect of a price change with the effect of a change in income.

The income and substitution The income and substitution effects of a price change areeffects of a price change are shown as a movement along shown as a movement along the demand curve.the demand curve.

The income effect of a price change,income effect of a price change, explains a movement along the curve. Specifically, we’re asking the question: Since the price of X has gone up, it essentially reduces my purchasing power and how will this affect the quantity demanded of X?

Objective 2: … the two reasons why a demand curve Objective 2: … the two reasons why a demand curve slopes downwardsslopes downwards Objective 2: … the two reasons why a demand curve Objective 2: … the two reasons why a demand curve slopes downwardsslopes downwards

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Understand the difference between a change in Understand the difference between a change in quantity demanded and a change in demandquantity demanded and a change in demandUnderstand the difference between a change in Understand the difference between a change in quantity demanded and a change in demandquantity demanded and a change in demand

A change in quantity demandedchange in quantity demanded refers to a movement along a demand curve in response to a price change.price change.


Understand the difference between a change in Understand the difference between a change in quantity demanded and a change in demandquantity demanded and a change in demandUnderstand the difference between a change in Understand the difference between a change in quantity demanded and a change in demandquantity demanded and a change in demand

A change in quantity demandedchange in quantity demanded refers to a movement along a demand curve in response to a price change.price change.


A change in price A change in price causes a movement causes a movement along a demand curve.along a demand curve.

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A change in demandchange in demand occurs when the entire demand curve shifts.shifts.

Objective 3: … a change in quantity demanded and a Objective 3: … a change in quantity demanded and a change in demandchange in demandObjective 3: … a change in quantity demanded and a Objective 3: … a change in quantity demanded and a change in demandchange in demand

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An increase in demandincrease in demand is represented by a rightwardrightward shift of the demand curve.


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An increase in demandincrease in demand is represented by a rightwardrightward shift of the demand curve.


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A decrease in demanddecrease in demand is represented by a leftwardleftward shift of the demand curve.


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Understand what causes demand to shiftUnderstand what causes demand to shift Understand what causes demand to shiftUnderstand what causes demand to shift Objective 4Objective 4Objective 4Objective 4

The demand curve is drawn with priceprice of the good in question on the vertical axis and the quantity demandedquantity demanded on the horizontal axis.

This implies price is a key determinant of the demand decision. But is price the only determinant?

No, there are many other factors that influence the demand decision.

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Understand what causes demand to shiftUnderstand what causes demand to shift Understand what causes demand to shiftUnderstand what causes demand to shift

1. The price of the product


Determinants of Demand include:Determinants of Demand include:Determinants of Demand include:Determinants of Demand include:

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2. Tastes and preferences of buyers



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3. Income of buyers



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3. Income of buyers

4. Price of related goods, namely, substitutes and complements



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3. Income of buyers


5. Number of buyers or Population



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3. Income of buyers




6. Consumers’ expectations about the future for example, about future prices and future income


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3. Income of buyers





7. Government policies that affect consumption





3. Income of buyers






8. Special Influences such as dating patterns, availability of subways and festive seasons


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Along a demand curve, what happens to the determinants other than the price of the good in question?

A changechange in any determinantin any determinant other than priceother than price causes a shift of the demand curve.

Objective 4: … what causes demand to shiftObjective 4: … what causes demand to shift Objective 4: … what causes demand to shiftObjective 4: … what causes demand to shift



3. Income of buyers

4. Price of related goods, namely, substitutes and

complements




8. Special Influences such as dating patterns, availability of subways and festive seasons

Determinants of Demand include:

Ceteris paribus (“all else constant”)Ceteris paribus (“all else constant”) is the requirement that when analyzing the relationship between two variables – such as the price and quantity demanded – other variables must be heldconstant.

Along a demand curve, only price and quantity demanded change. All other determinants are held constant.

Price and quantity demanded Price and quantity demanded change along a demand curve. change along a demand curve. All other determinants are heldAll other determinants are held constantconstant


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Example 1: Demand shifter – IncomeExample 1: Demand shifter – Income

Suppose Janet’s income increases. How does this affect her demand for coffee?


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It depends on whether the good is a normalnormal good or an inferiorinferior good.




It depends on whether the good is a normalnormal good or an inferiorinferior good.

NormalNormal goods: demand increasesincreases as income risesrises and decreases as income falls. In other words, there is a positivepositive relationship between income and demand.

Examples include concert tickets and restaurant meals.


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Suppose Janet’s income increases. How doesthis affect her demand for coffee, assumingcoffee is a normal good for Janet ?

Coffee is a Coffee is a normal goodnormal good


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A

Inferior goods:Inferior goods: demand decreasesdecreases as income rises,rises, and increases as income falls. In other words, there is a negativenegative relationship between income and demand.

Examples include laundromat services and bus rides.



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If coffee is an inferior inferior good to Janet, an increase in incomeincrease in income leads her to reducereduce her demanddemand for coffee. This is represented by a leftward shift of the demand curve.

Coffee is an Coffee is an inferior goodinferior good



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A

Normal and InferiorNormal and Inferior goods are defined in terms of the relationship between income and demand.



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A


The question you need to ask is: What happens to my demand for good X when my income increases or decreases?



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A



The qualityquality of the product is irrelevantirrelevant when defining a product as “normal” or “inferior”.



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A



The qualityquality of the product is irrelevantirrelevant when defining a product as “normal” or “inferior”.

A product may be normal to one person and inferior to another.



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There are two types of goods related in consumption: substitutes and complements.


Example 2: Demand shifter – change in the price Example 2: Demand shifter – change in the price of a related goodof a related good

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There are two types of goods related in consumption:

A SubstituteSubstitute in consumption is a product that is consumed in place of another. For example, coffee and tea, Coke and Pepsi.



There are two types of goods related in consumption:

A SubstituteSubstitute in consumption is a product that is consumed in place of another. For example, coffee and tea, Coke and Pepsi.

A ComplementComplement in consumption is a product that is consumed together with another product, For example, bagel and cream cheese, printer and ink cartridge.



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Suppose to Janet coffee and tea are substitutes. What happens to her demand for coffee when the price of tea falls?


Example 2: Demand shifter – change in the Example 2: Demand shifter – change in the price of a related goodprice of a related good

Suppose to Janet coffee and tea are substitutes. What happens to her demand for coffee when the price of tea falls?

A decrease in the price of teadecrease in the price of tea causes the quantity quantity demandeddemanded of tea to increase.



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In the coffee marketcoffee market, Janet’s demand decreases causing the coffee demanddemand curve to shift left.shift left.



In the coffee marketcoffee market, Janet’s demand decreases causing the coffee demanddemand curve to shift left.shift left.



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Definition of Substitutes in ConsumptionDefinition of Substitutes in Consumption

Two goods, C and T are substitutes insubstitutes in consumptionconsumption if an increase in the price of good T leads to a increase in the demand for good C and a decrease in the price of good T leads to a decrease in the demand for good C. In other words, there is a positive positive relationship between price of good T and the demand for good C.


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Example 3: Demand shifter - change in Example 3: Demand shifter - change in consumers’ expectations about future pricesconsumers’ expectations about future prices

Suppose consumers expect the price of silver to fall next month. How does this affect the demand for silver today?

Today, demand decreasesdecreases in anticipation of lower prices in the future.


Example 3: Demand shifter - change in consumers’ Example 3: Demand shifter - change in consumers’ expectations about future pricesexpectations about future prices

Suppose consumers expect the price of silver to fall next month. How does this affect the demand for silver today?

Today, demand decreasesdecreases in anticipation of lower prices in the future.

Today’s demand curve Today’s demand curve with some given set of with some given set of expectations about priceexpectations about price

Today’s demand Today’s demand curve with a new curve with a new set of expectations set of expectations about priceabout price

Today’s Today’s priceprice


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End of Module 2End of Module 2End of Module 2End of Module 2

Market Mechanism - DemandMarket Mechanism - DemandMarket Mechanism - DemandMarket Mechanism - Demand

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1 module 2 market mechanism demand. 2 demand understand the difference between demand and quantity...

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