Chapter 4 The Law of Demand What is Demand? Quantity demanded of a product or service is the number that would be bought by the public at a given price.

Chapter 4Chapter 4

The Law of DemandThe Law of Demand

What is Demand?What is Demand?

Quantity demanded of a product Quantity demanded of a product or service is the number that or service is the number that would be bought by the public at would be bought by the public at a given pricea given price

The Law of DemandThe Law of Demand

When a good’s price is lower, When a good’s price is lower, consumers will buy more of itconsumers will buy more of it

When a good’s price is higher, When a good’s price is higher, consumers will buy less of itconsumers will buy less of it

The Law of DemandThe Law of Demand

The Law of Demand is affected The Law of Demand is affected by two behavior patternsby two behavior patternsThe Substitution EffectThe Substitution EffectThe Income EffectThe Income Effect

The Substitution EffectThe Substitution Effect

As the price for one good rises As the price for one good rises compared to a similar good, compared to a similar good, consumers will substitute the consumers will substitute the similar good for their purchases.similar good for their purchases.

The Income EffectThe Income Effect

As prices go up, your money As prices go up, your money becomes worth less than it was becomes worth less than it was worth beforeworth before

People are less likely to buy the People are less likely to buy the good nowgood now

Demand ScheduleDemand Schedule

A demand schedule shows the A demand schedule shows the likely number of purchases likely number of purchases based on a series of arbitrarily based on a series of arbitrarily chosen priceschosen prices

Demand ScheduleDemand Schedule

Demand Schedule › Demand Schedule › Demand CurveDemand Curve

A Change (Shift) in A Change (Shift) in DemandDemand

If one of 5 other factors changes, If one of 5 other factors changes, the entire demand curve will shift the entire demand curve will shift to the left or rightto the left or right

The curve does NOT shift if the The curve does NOT shift if the price of the good is the only price of the good is the only changechange

A Change in Demand A Change in Demand (Graph)(Graph)

A Change in Quantity A Change in Quantity Demanded (Graph)Demanded (Graph)

IncomeIncome When people’s income changes, When people’s income changes,

demand shifts accordinglydemand shifts accordinglyNormal Goods – Normal Goods –

Higher income = higher demandHigher income = higher demandLower income = lower demandLower income = lower demand

IncomeIncome When people’s income changes, When people’s income changes,

demand shifts accordinglydemand shifts accordingly Inferior Goods –Inferior Goods –

Higher income = lower demandHigher income = lower demandLower income = higher demandLower income = higher demand

Consumer ExpectationsConsumer Expectations

If consumers expect a price to If consumers expect a price to rise in the future, current demand rise in the future, current demand increasesincreases

If consumers expect a price to If consumers expect a price to fall in the future, current demand fall in the future, current demand decreasesdecreases

PopulationPopulation When one sector of the When one sector of the

population grows, demand population grows, demand increases for products that increases for products that sector usessector uses

Fastest growing sector of the Fastest growing sector of the population today?population today?

Consumer Tastes and Consumer Tastes and AdvertisingAdvertising

Increased advertising can Increased advertising can increase consumer demandincrease consumer demand

Bad news about a product can Bad news about a product can decrease demanddecrease demand

Price of Related GoodsPrice of Related Goods

Complimentary Goods – goods Complimentary Goods – goods that are bought and used that are bought and used togethertogether Higher Complementary Price = Higher Complementary Price =

decrease in demand decrease in demand Lower Complementary Price = Lower Complementary Price =

increase in demandincrease in demand

Price of Related GoodsPrice of Related Goods

Substitute Goods – goods that Substitute Goods – goods that are used in place of one anotherare used in place of one another Higher Substitute Price = increase Higher Substitute Price = increase

in demand in demand Lower Substitute Price = decrease Lower Substitute Price = decrease

in demandin demand

Elasticity of DemandElasticity of Demand

Elasticity refers to how responsive Elasticity refers to how responsive the quantity demanded is to a the quantity demanded is to a change in priceschange in prices

Elasticity of DemandElasticity of Demand

An inelastic An inelastic good will still good will still sell about the sell about the same quantity same quantity even if the even if the price goes up price goes up or downor down

Elasticity of DemandElasticity of Demand

An elastic An elastic good will have good will have a higher a higher change in Qd change in Qd when there is when there is a price changea price change

Calculating ElasticityCalculating Elasticity

Elasticity = Elasticity =

% change in quantity demanded% change in quantity demanded

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% change in price% change in price

Calculating ElasticityCalculating Elasticity

If Elasticity is < 1, the good is If Elasticity is < 1, the good is inelasticinelastic

If Elasticity is > 1, the good is If Elasticity is > 1, the good is elasticelastic

If Elasticity = 1, the good has a If Elasticity = 1, the good has a unitary elastic demandunitary elastic demand

Factors Affecting Factors Affecting ElasticityElasticity

Availability of Substitutes – if you Availability of Substitutes – if you have no other options, demand have no other options, demand is inelastic.is inelastic.

Factors Affecting Factors Affecting ElasticityElasticity

Availability of Substitutes – if you Availability of Substitutes – if you have equally appealing options, have equally appealing options, demand is highly elasticdemand is highly elastic

Factors Affecting Factors Affecting ElasticityElasticity Relative Importance – what Relative Importance – what

percentage of your budget is percentage of your budget is spent on the good?spent on the good? If it is low, price changes will If it is low, price changes will

not alter demandnot alter demand If it is high, even small price If it is high, even small price

changes can greatly affect changes can greatly affect demanddemand

Factors Affecting Factors Affecting ElasticityElasticity

Necessities vs. Luxuries – Necessities vs. Luxuries – consumption of milk might stay consumption of milk might stay the same with price changes, the same with price changes, while consumption of lobster while consumption of lobster would greatly change with price would greatly change with price changeschanges

Factors Affecting Factors Affecting ElasticityElasticity Change over time – price Change over time – price

changes may produce inelastic changes may produce inelastic demand in the short term, but demand in the short term, but elastic demand long termelastic demand long term1970s fuel crisis – people still 1970s fuel crisis – people still

bought the same amount of bought the same amount of gas at first, but eventually gas at first, but eventually started buying smaller carsstarted buying smaller cars

Elasticity and RevenueElasticity and Revenue

Total Revenue – the amount of Total Revenue – the amount of money a company receives by money a company receives by selling its good or serviceselling its good or service

With elastic demand, revenue With elastic demand, revenue will decrease greatly with price will decrease greatly with price increasesincreases

Elasticity and RevenueElasticity and Revenue

With Inelastic demand, price With Inelastic demand, price increases will increase revenueincreases will increase revenue