Economics for Leaders Open Markets: Demand and Supply.

Economics for Leaders

Open Markets:Open Markets:

Demand and SupplyDemand and Supply


Choices are made at the Margin

Our only choice is the next choiceOur only choice is the next choice

Marginal = additional, next, a little Marginal = additional, next, a little more or a little lessmore or a little less


How much should we do?

WorkPlayStudySleep


As long as the marginal benefit is greater than the marginal cost you should continue the activity

MB=MC


Price IS an extremely powerful incentive

Analyze: When the money price changes, the opportunity cost of using a good or resource changes. The changed opportunity cost provides an incentive for people – consumers and producers – to change their behavior.

ERP #3:

People respond to incentives in predictable ways.


How are prices set?

By the Market!Interaction of buyers (consumers) and sellers (producers).


Necessary Conditions for markets

1.) Property Rights

2.) Clear “Rules of the Game”

3.) Freedom to Exchange

4.) Information


When incentives (Prices) change, behavior changes in predictable

ways.

When prices go up consumers demand a larger/smaller quantity?

Demand

The willingnesswillingness and abilityability to purchase goods and services at various prices.


When incentives (Prices) change, behavior changes in predictable

ways.

When prices go up consumers demand a larger/smaller quantity?

SmallerWhen prices go down consumers demand a larger/smaller quantity?

LargerAlways?Law of Demand P Q


LAW OF DEMANDPrice

Demand

As the price of a product increases, consumers buy less of a product

~~~~~~~~~~~~~~~~~

As the price of a product decreases, consumers buy more of a product

increases


The Law of Demand

If P then QD andIf P then QD

Note: What causes the change in the consumers’ behavior ?

(think: price effect)


What Is the Law of Demand?

The law of demand is the result of two separate behavior patterns that overlap, the substitution effect and the income effect. These two effects describe different ways that a consumer can change his or her spending patterns for other goods.


The Substitution Effect and Income Effect

The Substitution EffectThe substitution effect occurs when consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

The Income EffectThe income effect happens when a person changes his or her consumption of goods and services as a result of a change in real income.


The Demand ScheduleAn Individual demand schedule is a table that lists the quantity of a good a person will buy at each different price.

Chapter 4, Section 1Chapter 4, Section 1

A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.

Demand Schedules

Individual Demand Schedule

Price of a slice of pizza

Quantity demanded per day

Market Demand Schedule

Price of a slice of pizza

Quantity demanded per day

$.50

$1.00

$1.50

$2.00

$2.50

$3.00

5

4

3

2

1

0

$.50

$1.00

$1.50

$2.00

$2.50

$3.00

300

250

200

150

100

50

22 33jf What is the difference between a market and individual demand

schedule?


The Demand CurveMarket Demand Curve

3.00

2.50

2.00

1.50

1.00

.50

0

0 50 100 150 200 250 300 350Slices of pizza per day

Pri

ce p

er s

lic

e (i

n d

oll

ars)

Demand

22 33 Chapter 4, Section 1Chapter 4, Section 1

A demand curve is a graphical representation of a demand schedule.Three characteristics of every demand curve: 1.Downward sloping2.Must assume ceteris

paribus: EVERYTHING ELSE REMAINS THE SAME

3.Relationship between price and quantity

What is the one factor that causes a shift in the quantity demanded?

PRICE!!


Pictures of Demand

Price

QD

0

$8

90


Movement along the demand curve 1.) is a result in a consumer changing their behavior based on a change in price.price.2.) Increase in quantity demanded is demonstrated by moving down the demand curve

• 3.) Decrease in quantity demanded is demonstrated by moving up the demand curve

• Why can’t a change in demand from other factors be demonstrated by moving along thedemand curve?


Changes in DemandDemand Shifters:

When we drop the ceteris paribus rule and allow other factors to change we no longer move along the demand curve.

• Instead, the entire demand curve shifts


Shift=Change in demand

Means At every price, consumer buy a different quantity than before


Drinking beer will help you lose weight! Americans Demand more Beer!Americans demand more pints of beer at every priceAn increase in demand appears as a shift to the rightD1-origanl demand curveD2 – New demand curve adjusted for beer causing weight loss.


Drinking beer will turn your teeth black and your skin to break-out in permanent acne!

Americans demand less beer!Americans demand less beer at every price!A decrease in demand appears as a shift to the left

• D- original demand curve

• D1-adjusting for beer causing black teeth & pimples


What influences demand?

Demand ShiftersIncomeConsumer ExpectationsPopulationTaste and preference and advertising Price of related goods


1.) Income

Most products we purchase are normal goodsIf, Ben’s income increases from $200 per week to $300 per week, it will cause him of buy more Starbuck’s ground coffee at every price level. If we plotted his new demand schedule on a graph it would produce a curve to the right of Ben's original curve. For each of the prices on the vertical axis, the quantity demanded will be greater for normal goods This is called an increase in demand


Inferior goods are goods that you would buy in smaller quantities, or not at all, if you income were to rise and you could afford something better. Ben gets demoted. He takes a pay-cut - his income decreases He now instead of making $200 dollars a week, he is making $50. He can’t afford his Starbucks! He now has to buy Folgers; and less Starbucks This causes a decrease in his demand for Starbucks & the demand curve to shift to the left.

Income increases-Starbucks demand increases at every price

Income decreases:Starbucks demand decreases at every price


2.) Consumer Expectations:

Our expectations about the future can affect our demand for certain goods todayMs. Morse has been eyeballing a pair of Jimmy Choos for months. A very nice salesperson lets me know the price on the shoes will go up in a weekI’m buying the shoes today to make sure I get the lower priceThe expectation of a higher price in the future causes my immediate demand to increase!


• What if the salesperson lets me know that the shoes are going to be on sale next week!

• My immediate demand for my Jimmy Choos is going to fall to zero!

• I’m going to wait to buy the shoes next week

• If expectation that price will drop, current demand will decrease.


3.) Population

When the population grows, what do they need; what do they demand?

there is an increase in demand for goods and services


4.) Consumer Tastes and Advertising

Fanny packs – who would have thunk this would trend?How about Ed Hardy? People used to pay $65-$100 per t-shirt. Now you can get them for $4.99 at Ross! Rock Rivals, Uggs, Air Jordans – how long will these trends last?Changes in taste and preferences cannot be explained by changes in income or populations or worries about future price increase


Companies spend copious amounts of money on advertising; hoping to increase demand – seems like it’s paying off. All you

have to do is consider the amount of money spent on one minute of advertising during the Super Bowl every year.


5.) Price of Related Goods

The demand curve for one good can be affected by a change in the demand for anotherComplements:Demand for skis go upDemand for ski boots go upPrice $ increase in skis go upWhat happens to the demand for skis?How about the demand for ski boots?


SubstitutesIf the price of snowboard rises, what would the effect on the demand for skis?Snowboards are considered a substitute for skis, because consumer often buy one or the other, but not both.Demand for skis will increaseWhat if there is a decrease in the price of snowboards? How would this affect the demand for skis?Consumer will buy fewer skis at every price.


Demand shifters: examples

What will happen to the demand for hamburger if the price of hotdogs increases?What will happen to the demand for Snickers if it is discovered that chocolate makes you beautiful?


Shifting the Curve (cont.)An increase in demand is shown by moving the demand curve to the right–What would cause an increase in demand?

A decrease in demand is shown by moving the demand curve to the left–What would cause a decrease in demand?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~


What Is Elasticity of Demand?

Demand for a good that consumers will continue to buy despite a price increase is inelastic.

Elasticity of demand is a measure of how consumers react to a change in price.

Demand for a good that is very sensitive to changes in price is elastic.

Chapter 4, Section 3Chapter 4, Section 32211Why would a prescription drug, like insulin, have inelastic demand for a person with

diabetes?


The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income.

Elasticity and Revenue:

A company’s total revenue is the total amount of money the company receives from selling its goods or services. Firms need to be aware of the elasticity of demand for the good or service they are providing. If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.


Elasticity and Revenue

Elastic Demand:Elastic Demand:

Total revenue

risesAs the price is

lowered….

As the price is raised….

Total revenue

falls


Elasticity and Revenue

Inelastic Demand:

Total revenue

falls

As the price is raised….


Factors Affecting ElasticityFactors Affecting Elasticity

1. Availability of Substitutes

If there are few substitutes for agood, then demand will not likelydecrease as price increases. The

opposite is also usually true.

2. Relative Importance

Another factor determining elasticityof demand is how much of yourbudget you spend on the good.

3. Necessities versusLuxuries

Whether a person considers a goodto be a necessity or a luxury has a

great impact on the good’s elasticityof demand for that person.

4. Change over Time

Demand sometimes becomes moreelastic over time because peoplecan eventually find substitutes.

Chapter 4, Section 3Chapter 4, Section 32211What are some other factors that you feel could impact a

consumers response to a change in the price of a product?

Economics for Leaders Open Markets: Demand and Supply.

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