Unit Two: Market Equilibrium

1. Unit Two: Market Equilibrium Topic: Demand

2. Learning Targets • I can define demand. • I can explain the relationship between price and quantity demanded. • I can explain why the demand curve is downward-sloping. • I can explain the price elasticity demand, and how is it used. • I can identify the determinants of demand and how they are used.

3. Things to remember… • We only change one thing at a time. • We assume that everything else stays the same. • Models are simplified versions of reality. • ALWAYS title your graph with the name of a good or service. You should be able to say “this graph is for the demand for title,” with it actually making sense.

4. Demand • Def: the amount of a good or service that consumers are willing and able to purchase at certain prices at a certain time. • Consumers base their willingness to buy an item on the utility of that item, therefore, quantity depends on utility (price). • Purchasing power: the amount of stuff you can buy with your money. • Price (P) is the ONLY thing that can change quantity demanded (QD).

5. Demand Curve P Good X The demand curve slopes downward because of: 1. The Law of Demand 2. Income Effect 3. Substitution Effect D Q

6. Reasons for Downward-Sloping Curve • Law of demand: As price increases, QD decreases and vice versa (inverse relationship). • Income effect: As the price of a good that consumers normally purchase falls, their purchasing power increases. • Substitution effect: Consumers will buy the cheaper of two similar goods in order to increase purchasing power.

7. Price Elasticity of Demand • Measures the degree of change in QD as a response to a change in P (the “size” of a change in QD). • QD is relatively unresponsive to price change = inelastic • QD is relatively responsive to price change = elastic • Determinants: • Number of substitutes (lots = elastic) • Proportion of income (large = elastic) • Degree of necessity (luxury = elastic) • Time period to adjust to price change (long = elastic)

8. Practice Use the elasticity determinants to determine which of the two items would be more elastic and which would be more inelastic. • Diamond earrings vs. socks • Designer jeans vs. antibiotics • Bag of potato chips vs. barbeque grill

9. Change in Demand • A change in demand (at each and every price) occurs because of a non-price determinant. • Five non-price determinants of demand (RIPEM): • Related goods • Income • Preferences • Expectations • Market size

10. An increase in D will shift the curve to the right. A decrease in D will shift the curve to the left. Change in Demand Good X Good Y P P D2 D D2 D Q Q

11. RIPEM: Related Goods • Def: goods that have a relationship, either as complements or substitutes to one another; a change in the price of one good will affect the demand for the other good. • Substitute goods: goods that can be used in the place of one another. • Ex. hot dogs and hamburgers, tennis shoes and boots, tater tots and french fries, etc. • An increase in the price of one substitute good will cause an increase in the demand for the other good. • Ex. If the price of tater tots increases, the demand for french fries will increase because french fries are now relatively less expensive.

12. RIPEM: Related Goods • Complementary goods: goods that are used together. • Ex. chips and salsa, shoes and socks, MP3 players and MP3 music, etc. • An increase in the price of one complementary good will decrease the demand for the other. • Ex. An increase in the price of chips will decrease the demand for salsa; if people are not buying as many chips, they will need less salsa.

13. Practice For each of the following, state whether the demand for hot dogs will increase or decrease. • The price of mustard increases. • The price of hamburgers decreases.

14. RIPEM: Income • Def: as consumers’ incomes change, demand for normal and inferior goods will change. • Normal goods: goods that consumers buy more of when their incomes increase. • Ex. steaks, diamond earrings, cars. • Inferior goods: goods that consumers buy less of when their incomes increase. • Ex. Ramen noodles, sterling silver earrings, public transportation.

15. Practice For each of the following, state which good would be normal and which good would be inferior. • Cheerios vs. Grand Slam Breakfast at Denny’s • Godiva chocolates vs. Tootsie Rolls • White rice vs. rib-eye steak

16. RIPEM: Preferences • Def: as trends, fads, technology, health concerns, etc. change, consumers will change their demand for particular goods and services. • Ex. The demand for typewriters decreased as more people/businesses started using computers. • Ex. If there were contaminants in tap water, the demand for bottled water would increase.

17. Practice For each of the following, state whether the demand for hot dogs will increase or decrease. • Hot dogs help prevent cataracts. • Hot dog eating contests decline in the U.S. • Hot dogs are now made with 100% beef. • The number of vegetarians increases.

18. RIPEM: Expectations • Def: if consumers expect the price of a good or service to change in the future, they will change current demand. • Think of it as “stocking up” while the price is low. • Ex. If the price of airline tickets are going to increase in a few weeks, people will buy their tickets now (demand will increase now).

19. Practice For each of the following, state whether the demand for the underlined product will increase or decrease NOW. • The price of winter coats will go down in a few months. • The price of bottled water is expected to go up when hurricane season starts in a few weeks.

20. RIPEM: Market Size • Def: the size of a population will change the demand for goods and services that the population will use. • Ex. A baby boom will increase the demand for diapers.

21. Practice For each of the following, state what will happen to the demand for the underlined good. • A large group of people are expected to retire soon (cruises). • A natural disaster on the Gulf Coast forces people to seek refuge in Dallas (housing in Dallas).