Chapter 4

Demand

Objectives:

Explain the law of demand. Describe how the substitution effect and the

income effect influence decisions. Create a demand schedule for an individual and

a market. Interpret a demand graph using demand

schedules.

Section 1: Understanding

Demand

One free Test Pass

The desire to own something and be able to

pay for it The law of Demand

Consumers will buy more of a good when its price is lower and less when the price is higher

Demand

The Substitution Effect

Consumers react to a rise in the price of one good by consuming less of that good and more of a substitute good

The Income Effect The change in consumption that results when a

price increase caused real income to decline Feeling richer or poorer

Economists measure consumption not the

amount of money spent to buy it

To have a demand for a good, you must be

willing and able to buy it at the specified price. Demand means that you want the good and can afford to buy it. You may desperately want a new car, a laptop computer, or a trip to Alaska, but if you can’t truly afford any of these goods, you do not demand them.

Can I afford that?

A table that lists the quantity of a good that a person will purchase at various prices

A Demand Schedule

Market Demand Schedules Table that lists the quantity of a good all

consumers in a market will buy at various prices

The Demand Graph Graphic Representation of a demand schedule

Objectives:

Explain the difference between a change in quantity demanded and a shift if the demand curve

Identify the factors that create changes in demand and that can cause a shift in the demand curve.

Give an example of how a change in demand for one good can affect demand for a related good.

Section 2: Shifts in the Demand Curve

Ceteris Paribus

“all things held constant” Demand curves are only accurate as long as

there are no other changes that could affect price EX: natural disasters

Changes in Demand

Moving from $2 to $3 = Movement is referred to as decrease in the

quantity demanded (or increase in the quantity demanded)

Income

Normal goods – goods that consumers demand more of when their income increases

Inferior goods – goods you would buy in smaller quantities, or not at all, if you income were to rise and you could afford something better

Consumer Expectations Population Demographics – statistical characteristics of a

population Age, race, gender etc.

Consumer Tastes and Advertising

Complements

2 goods that are bought and used together Substitutes

Goods that are used in place of one another

Prices of Related Goods

Objectives:

Explain how to calculate elasticity of demand. Identify factors that affect elasticity. Explain how firms use elasticity and revenue to

make decisions.

Section 3: Elasticity of Demand

Elasticity of Demand

Measure of how consumers respond to price changes

Elastic Demand that is very sensitive to change

Inelastic Demand that is not very sensitive to change

Elasticity

Take the percentage change in the quantity of

the good demanded Divide this number by the percentage change

in the price of the good = elasticity of demand

Calculating Elasticity

Law of demand implies that the result will

always be negative Increase in price of a good will always be

negative Why?

Increase in the price of a good will always decrease the quantity demanded

Decrease in price of a good will always increase the quantity demanded

Price Range Values of Elasticity

Less than 1 = inelastic Greater than 1 = elastic Exactly equal means unitary elastic

Availability of Substitutes

Life-saving medications? Relative Importance

Shoelaces? Clothing if you spend 50% of your budget on

clothes?

Factors Affecting Elasticity

Necessities v. Luxuries

Milk? Steak?

Change Over Time Vehicles?

1. Availability of substitute goods 2. Limited budget 3. Perception of goods

Computing a Firms Total Revenue

Total revenue - amount of money the company receives by

selling its goods 2 factors:

1. price of the goods 2. quantity sold

Elasticity and Revenue

Total Revenue and Elastic Demand

Price increase can reduce total revenue

Total Revenue and Inelastic Demand

Raise prices Less demanded Greater revenue (higher price makes up for

demand)

Elastic or inelastic?

Pricing decisions

Elasticity and Pricing Policies