DEMAND “How Markets Work”. What is Demand? Ferrari F-430 Retail: $ 350,000 Lamborghini Gallardo Retail: $310,000 Rolex Crown Collection Retail: $ 64,

DEMAND

“How Markets Work”

What is Demand?What is Demand?

Ferrari F-430 Retail: $ 350,000

Lamborghini Gallardo Retail: $310,000

Rolex Crown Collection Retail: $ 64, 500

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Does WANT = DEMAND?

Three Criteria have to be met:1. Desire 2. Ability3. Willingness

Demand = the desire, ability, and willingness to purchase goods and services (G/S).

The AMOUNT consumers will BUY @ various PRICES!

• Ceteris paribus, as prices rise, the QUANTITY DEMANDED falls.

Vice versa

• Ceteris paribus, as prices fall, the QUANTITY DEMANDED increases.

The LAW of DEMANDThe LAW of DEMAND

Three Reasons for the Law of Demand

We call these the:

Income Effect

Substitution Effect

Diminishing Marginal Utility

INCOME EFFECTINCOME EFFECT

• As prices go down, consumers “real’ income goes up! They can buy more with each dollar.

• As prices go up, consumers “real” income goes down! They can buy less with each dollar.

P

P

I

I

SUBSTITUTION SUBSTITUTION EFFECTEFFECT

• As the price for a good or service increases, consumers will substitute another good or service that is cheaper.

DIMINISHING MARGINAL UTILITY

• As we buy more and more of a good our level of satisfaction (utility) diminishes.

• We will not continue to buy more unless the seller lowers the price.

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Demand ScheduleDemand Schedule

• A TABLE showing the amount that will be purchased at various prices.

Price Quantity

$1.00 10

$2.00 5

$3.00 2

Demand Curve

$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10

12

11

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

Price Quantity $0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0

A GRAPH that shows the AMOUNT that will be purchased at VARIOUS PRICES.

Price Elasticity of Demand

Demand elasticity: A measure of how much the quantity demanded of a good responds to a change in the price of that good.

Demand is elastic if the quantity consumers buy changes substantially when the price of the good changes

Demand is inelastic if the quantity demanded changes proportionately less than the change in price.

Determinants of Price Elasticity of Demand

If the good is a luxury. The longer the time

period. The larger the number of

close substitutes. The more narrowly

defined the market

Demand tends to be more inelastic:

If the good is a necessity The shorter the time

period. The smaller the number

of close substitutes. The more largely defined

the market.

Demand tends to be more elastic :

Elastic Demand

Quantity

Price

4

$51. A 22%increasein price...

Demand

100502. ...leads to a 67% decrease in quantity.

An elastic demand curve is fairly flat – showing small changes in prices cause large changes in quantity demanded

Inelastic Demand

Quantity

Price

4

$51. A 22%increasein price...

Demand

100902. ...leads to a 11% decrease in quantity.

An inelastic demand curve is fairly steep – showing changes in prices lead to smaller changes in quantity demanded

Changes in QUANTITY Demanded…

• A change in QUANTITY DEMANDED means consumers are BUYING MORE OR LESS because of a CHANGE IN PRICES.

• A change in QUANTITY DEMANDED is demonstrated by MOVEMENT ALONG a demand curve caused by a CHANGE IN PRICE

D1

Price (P)

Quantity Demanded (QD)

A

B

Q1 Q2

P1

P2

QD

00

What causes a change in quantity demanded?

A change in price.

The LAW of DEMANDThe LAW of DEMAND

• CETERIS PARIBUS, as prices rise, the quantity demanded falls and vice versa along a constant demand curve.

CETERIS PARIBUS means “While one thing changes (price), everything else remains the same.”

Will you never be willing or able to buy this car?

IS DEMAND…IS DEMAND…

Changes in DEMAND

• A Change in Demand means:– Consumers purchase more or less products

at EVERY PRICE LEVEL causing a change in the demand schedule and a shift of the curve.

D1

Price (P)

Quantity Demanded (QD)

D2 D3

0

0

D

P 1

P 2

Changes in DEMAND

• Demand changes when something other than price changes the market conditions.

• Non-price Determinants of Demand– Income of Consumers– Number of Buyers (population changes)– Expectations of Prices or Income in the Future– Prices of Related Goods (Substitute goods or

Complementary goods)– Tastes & Preferences of Consumers