1 The Concept of Demand The Demand for Goods and Services.

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The Concept of DemandThe Concept of Demand

The Demand for Goods and The Demand for Goods and ServicesServices

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Objective:Objective:

To determine how people respond to To determine how people respond to price changes over time with respect price changes over time with respect to to commodities and factors of commodities and factors of productionproduction..

We will be dealing primarily with the We will be dealing primarily with the commodity markets, commodity markets, but we will look but we will look at a few factors of production as well.at a few factors of production as well.

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MORE PREFERRED MORE PREFERRED RATHER THAN LESSRATHER THAN LESS

Remember that most people prefer Remember that most people prefer more rather than less economic more rather than less economic goods and services;goods and services;

and that we will probably never and that we will probably never reach the point in our lifetime at reach the point in our lifetime at which so many goods and services which so many goods and services are produced and distributed that are produced and distributed that no one wants more.no one wants more.

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Rational BehaviorRational Behavior

We must manage our limited We must manage our limited incomes so that we satisfy as incomes so that we satisfy as many wants as possible,many wants as possible,

or satisfy those wants having or satisfy those wants having the highest priority.the highest priority.

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Rational BehaviorRational Behavior

1. It is irrational to spend money 1. It is irrational to spend money indiscriminately and without anyindiscriminately and without any

attention to the limitations of attention to the limitations of our incomes.our incomes.

2.2. It is prudent to carefully It is prudent to carefully consider alternative ways of consider alternative ways of spending our spending our limited incomes limited incomes consistent with maximum consistent with maximum satisfaction satisfaction (UTILITY)(UTILITY)..

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SUBSTITUTES:SUBSTITUTES:

There are substitutes for almost There are substitutes for almost anything !!!!anything !!!!

Most goods are not free. They Most goods are not free. They can only be obtained by can only be obtained by sacrificing something else that sacrificing something else that is also a good (usually money, is also a good (usually money, or what that money could buy)or what that money could buy)

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SUBSTITUTES:SUBSTITUTES:

11. This sacrifice is measured by . This sacrifice is measured by PRICEPRICE

2. Intelligent choice among 2. Intelligent choice among substitutes requires a balancing of substitutes requires a balancing of additional costs against additional additional costs against additional benefits.benefits.

Marginal Cost vs. Marginal RevenueMarginal Cost vs. Marginal Revenue

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Necessities Versus WantsNecessities Versus Wants

We think of food, clothing, and We think of food, clothing, and shelter as necessities. shelter as necessities.

Are they?Are they?

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Necessities Versus WantsNecessities Versus Wants

Other items such as clean air, Other items such as clean air, transportation, personal transportation, personal safety, quality medical care, safety, quality medical care, and formal education are often and formal education are often referred to as necessities.referred to as necessities.

Are They?Are They?

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Necessities Versus WantsNecessities Versus Wants

At some price, the distinction At some price, the distinction between between necessities necessities and and wantswants becomes clear.becomes clear.

How much are you willing to pay for How much are you willing to pay for Clean Air? Quality Medical Care? A Clean Air? Quality Medical Care? A College Education? Personal College Education? Personal Safety?Safety?

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Substitutes:Substitutes:

A varying number of substitutes A varying number of substitutes can be found for almost all can be found for almost all wants.wants.

1. Any substitutes for food ?1. Any substitutes for food ?

What are our basic food needs?What are our basic food needs?

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NCSU Meal PlanNCSU Meal Plan

The institutional food served at The institutional food served at NCSU’s dining hall is far above NCSU’s dining hall is far above our basic food needs, but the our basic food needs, but the majority of you do not like it !majority of you do not like it !

You You WANT WANT better tasting food, better tasting food, you do not you do not NEED NEED it !it !

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Number of SubstitutesNumber of Substitutes

1. Not many substitutes for 1. Not many substitutes for food,food,

2. 2. BUTBUT there is just about an there is just about an endless number of substitutes endless number of substitutes for a pound of Maxwell House for a pound of Maxwell House coffee sold at the Food Lion on coffee sold at the Food Lion on Avent Ferry Road.Avent Ferry Road.

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IMPORTANT NOTEIMPORTANT NOTE

As we more narrowly As we more narrowly define a commodity, the define a commodity, the number of available number of available substitutes increase !substitutes increase !

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Gasoline Example:Gasoline Example:

How many substitutes are there How many substitutes are there for gasoline?for gasoline?

How many substitutes are there How many substitutes are there for a gallon of premium for a gallon of premium unleaded at the BP station on unleaded at the BP station on Hillsborough Street?Hillsborough Street?

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At the consumer level At the consumer level

What are the substitutes for beef?What are the substitutes for beef? Do we need beef?Do we need beef?

What are the substitutes for rose What are the substitutes for rose bushes?bushes?

Do we need rose bushes?Do we need rose bushes?

What are the substitutes for What are the substitutes for potatoes?potatoes?

Recent TV ads would suggest “Stove Top Stuffing”Recent TV ads would suggest “Stove Top Stuffing”

Do we need potatoes?Do we need potatoes?

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Therefore:Therefore:

Each consumer will choose from Each consumer will choose from among varying alternatives among varying alternatives (substitutes) (substitutes) based upon based upon his/her personal preferences his/her personal preferences (degrees of want) (degrees of want) and the and the associated prices of the associated prices of the alternatives alternatives (substitutes)(substitutes)..

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Consumer Decisions Are Consumer Decisions Are Based Upon:Based Upon:

Additional expected costs Additional expected costs and and additional expected benefits additional expected benefits derived from available derived from available information.information.

Completely adequate information Completely adequate information is seldom available, information is seldom available, information itself is an economic good.itself is an economic good.

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When do we stop When do we stop gathering information?gathering information?

The more relevant information a The more relevant information a rational consumer or producer rational consumer or producer collects, collects,

The better will be the decisions The better will be the decisions they make, on average, in general.they make, on average, in general.

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When do we stop When do we stop gathering information?gathering information?

At some point however, consumers At some point however, consumers and producers must address and producers must address marginal analysis:marginal analysis:

At what point does the marginal At what point does the marginal cost of acquiring additional cost of acquiring additional information exceed the marginal information exceed the marginal benefit of acquiring additional benefit of acquiring additional information?information?

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THE DEMAND CURVETHE DEMAND CURVEPricePrice

Quantity demanded per unit of Quantity demanded per unit of timetime

Demand Curve

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The Demand CurveThe Demand Curve

Y AXIS = the sacrifices that must be Y AXIS = the sacrifices that must be mademade

to obtain a commodity to obtain a commodity

- price- price

X AXIS = the QUANTITY DEMANDEDX AXIS = the QUANTITY DEMANDED

per unit of timeper unit of time

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Definition of DemandDefinition of Demand

The willingness and ability of buyers to The willingness and ability of buyers to purchase a given amount of goods or purchase a given amount of goods or services, over a range of prices, over a services, over a range of prices, over a given period of time.given period of time.

The relationship of the quantity of a The relationship of the quantity of a good that will be bought at various good that will be bought at various prices can be presented in the form of prices can be presented in the form of a demand a demand schedule or portrayed schedule or portrayed graphically as a demand curve.graphically as a demand curve.

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Definition of DemandDefinition of Demand

OROR

The relationship showing the The relationship showing the various amounts of a commodity various amounts of a commodity that buyers would be willing and that buyers would be willing and able to purchase at possible able to purchase at possible alternative prices during a given alternative prices during a given time period, all other things time period, all other things remaining constant.remaining constant.

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Quantity Demanded (QQuantity Demanded (Qdd))

The specific amount of a commodity The specific amount of a commodity that people are willing and able to that people are willing and able to buy at a buy at a PARTICULAR (specific)PARTICULAR (specific) price, during a given period of price, during a given period of time.time.

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Quantity Demanded (QQuantity Demanded (Qdd))

Qd is a Qd is a flow variable flow variable (measured (measured over a period of time) rather than over a period of time) rather than a a stock variable stock variable (measured at a (measured at a point in time).point in time).

One point on the demand curve One point on the demand curve represents a single price : quantity represents a single price : quantity demanded relationship demanded relationship PER UNIT PER UNIT OF TIME.OF TIME.

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Quantity Demanded (QQuantity Demanded (Qdd))

A change in quantity demanded A change in quantity demanded is represented by a movementis represented by a movement

along the existing demand along the existing demand curve.curve.

PP

Q

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Law of Demand:Law of Demand:

Principle stating that as the price Principle stating that as the price of a commodity increases, the of a commodity increases, the less consumers will purchase less consumers will purchase per unit of time, ceteris paribus.per unit of time, ceteris paribus.

As price decreases, the quantity As price decreases, the quantity demanded increases per unit ofdemanded increases per unit of

time, ceteris paribus.time, ceteris paribus.

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Law of DemandLaw of Demand

P P QQddc.p.c.p.

P P QQdd c.p. c.p.

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MINIMUM WAGE LAWS: MINIMUM WAGE LAWS: A practical exampleA practical example

Assume the minimum wage is $4.25 Assume the minimum wage is $4.25 per hour and the government per hour and the government proposes to increase the minimum proposes to increase the minimum wage to $5.25 per hour. wage to $5.25 per hour.

This means that employers must This means that employers must pay an additional $1.00 per hour, pay an additional $1.00 per hour, plus ?plus ?

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MINIMUM WAGE LAWS: MINIMUM WAGE LAWS: A practical exampleA practical example

What do NC employers do ?What do NC employers do ?

1. Will they decide to hire fewer 1. Will they decide to hire fewer people?people?

2.2. Will they substitute Will they substitute toward less expensive inputs?toward less expensive inputs?

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MINIMUM WAGE LAWS: MINIMUM WAGE LAWS: A practical exampleA practical example

Wage Wage Demand for Minimum Wage WorkersDemand for Minimum Wage Workers

By Employers of Minimum Wage WorkersBy Employers of Minimum Wage Workers

5.255.25

4.254.25

2400 25002400 2500 Quantity of LaborQuantity of Labor

Labor Demand Curve

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Minimum Wage WorkersMinimum Wage Workers

Research evidence shows that Research evidence shows that an increase in the minimum an increase in the minimum wage does cause some wage does cause some unemployment.unemployment.

That unemployment however is That unemployment however is concentrated among teenage concentrated among teenage (16-19 years) workers(16-19 years) workers

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Effect of Min. Wage Effect of Min. Wage IncreaseIncrease

It is estimated that a 10 percent It is estimated that a 10 percent increase in the minimum wage will increase in the minimum wage will reduce teenage employment by 1 reduce teenage employment by 1 to 3 percent.to 3 percent.

Young adults (age 20 to 24) are less Young adults (age 20 to 24) are less affected; a 10 percent increase in affected; a 10 percent increase in minimum wage results in minimum wage results in unemployment of 1 percent or less.unemployment of 1 percent or less.

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An Increase in the Min. An Increase in the Min. Wage?Wage?

President Clinton (1995) has proposed President Clinton (1995) has proposed a 90 cent increase in the minimum a 90 cent increase in the minimum wage ($4.25 to $5.15) over a two year wage ($4.25 to $5.15) over a two year period.period.

From $4.25 to $4.75 the first year, andFrom $4.25 to $4.75 the first year, and

(October 1, 1996)(October 1, 1996)

From $4.75 to $5.15 the second year.From $4.75 to $5.15 the second year.

(September 1, 1997)(September 1, 1997)

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Historical Minimum Wage Historical Minimum Wage DataData

The Federal Hourly Minimum The Federal Hourly Minimum Wage Since Its InceptionWage Since Its Inception

http://www.cnn.com/US/9608/20/http://www.cnn.com/US/9608/20/minimum.wage.sign/minimum.wage.sign/graph_mimimum.wage.gifgraph_mimimum.wage.gif

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To Read More on the Min. To Read More on the Min. WageWage

Read page 133, (M&B), 14th: Read page 133, (M&B), 14th: Minimum WageMinimum Wage

Read page 314, (M&B), 14th: The Read page 314, (M&B), 14th: The Minimum Wage ControversyMinimum Wage Controversy

These readings are a little advanced These readings are a little advanced for where we are at this time.for where we are at this time.

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Machinery & Equipment Machinery & Equipment Dealers?Dealers?

What have machinery and What have machinery and equipment dealers done whenever equipment dealers done whenever the minimum wage was increased?the minimum wage was increased?

PPoutputoutput

EEEELaborLabor = PE = PELaborLabor X ----------- X ----------- EE EELaborLabor

PPLaborLabor

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Inflation and Relative Inflation and Relative PricesPrices

Many people often argue with Many people often argue with economists that the law of economists that the law of demand is wrong !demand is wrong !

These people, however, have These people, however, have forgotten to take inflation into forgotten to take inflation into account !!account !!

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1.1. The inflation of the late The inflation of the late 70's and early 80's in the US 70's and early 80's in the US resulted in apparent price resulted in apparent price increases.increases.

2. Many of these price increases 2. Many of these price increases were not real increases at all.were not real increases at all.

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Inflation is an increase in the Inflation is an increase in the general price level or an general price level or an increase in theincrease in the average average money price of goods and money price of goods and services and is usually services and is usually measured by measured by the CPI the CPI

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More Information on the More Information on the CPICPI

CPI informationCPI information

hhttp://ttp://stats.bls.gov:80/cpihome.htmstats.bls.gov:80/cpihome.htm

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1. If the price of all items 1. If the price of all items double, including human labor, double, including human labor, management, land, and capital management, land, and capital items, then no good would items, then no good would have changed in real price.have changed in real price.

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2. Therefore, doubling of the 2. Therefore, doubling of the price of gasoline will not price of gasoline will not necessarily induce people to necessarily induce people to use less gasoline if at the use less gasoline if at the same time incomes and all same time incomes and all other prices also double.other prices also double.

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WARNING !!!WARNING !!!

3. All money prices do not 3. All money prices do not change in equal proportions.change in equal proportions.

This is one reason why inflation This is one reason why inflation can be a big problem.can be a big problem.

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If the price of beef increases 10%, If the price of beef increases 10%, and the average of all other and the average of all other prices increase 10%, then the prices increase 10%, then the price of beef did not increase price of beef did not increase relative to all other prices.relative to all other prices.

The real price of beef is The real price of beef is unchangedunchanged..

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IN THIS COURSE, WHEN THE IN THIS COURSE, WHEN THE PRICE OF A COMMODITY IS PRICE OF A COMMODITY IS SAID TO INCREASE, WE ARE SAID TO INCREASE, WE ARE ASSUMING THAT THE PRICES ASSUMING THAT THE PRICES OF ALL OTHER GOODS AND OF ALL OTHER GOODS AND SERVICES HAVE NOT SERVICES HAVE NOT INCREASED, THEY REMAIN INCREASED, THEY REMAIN UNCHANGED (ceteris paribus).UNCHANGED (ceteris paribus).

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Therefore, we are looking at the Therefore, we are looking at the price change of a commodity price change of a commodity

RELATIVE RELATIVE to the price of to the price of another good or service, OR to another good or service, OR to an index of all other prices !an index of all other prices !

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Relative Price:Relative Price:

is the price of any item is the price of any item compared to the price of other compared to the price of other commodities, or relative to an commodities, or relative to an average (or index) of all other average (or index) of all other prices in theprices in the economy.economy.

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Nominal Price:Nominal Price:

the price paid in dollars for a the price paid in dollars for a commodity at a particular point in commodity at a particular point in time.time.

The Current Sticker PriceThe Current Sticker Price

The price you an I pay in current dollars The price you an I pay in current dollars for any commodity at any point in for any commodity at any point in time are called time are called nominal pricesnominal prices..

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Consumer buying decisions are Consumer buying decisions are dependent upon dependent upon relative price.relative price.

NOT Nominal PricesNOT Nominal Prices

Consumers observe nominal Consumers observe nominal prices, but base buying prices, but base buying decisions on relative pricesdecisions on relative prices

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An Example:An Example:

Nominal Price Nominal Price Relative Price Relative Price

Price Price Price Price Price Price PricePrice

3 yrs ago today 3 yrs ago today 3 yrs ago 3 yrs ago todaytoday

Hamburger $1.00Hamburger $1.00 $3.00 $3.00 $1.00 / $ .50 = 2 $3.00 / $1.00 / $ .50 = 2 $3.00 / $2.00 = 1.5$2.00 = 1.5

Hot dogsHot dogs $ .50 $ .50 $2.00 $2.00 $.50 / $1.00 = .50 $.50 / $1.00 = .50 $2.00 / $3.00 = .67$2.00 / $3.00 = .67

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An Example Using the CPIAn Example Using the CPI

Nominal Price Nominal Price Relative Price Relative Price

Price Price Price Price Price PricePrice Price

3 yrs ago today 3 yrs ago today 3 yrs ago today3 yrs ago today

Hamburger $1.00Hamburger $1.00 $3.00 $3.00 ($1.00 / 149.7) ($3.00 /161.3)($1.00 / 149.7) ($3.00 /161.3)

X 100 = $.67 X X 100 = $.67 X 100 = $1.86100 = $1.86

Average ofAverage of

prices in the 149.7 161.3prices in the 149.7 161.3

economy (CPI)economy (CPI)