CH 4 The Law of Demand

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CH 4 The Law of Demand. Define the law of demand Substitutions Analyze the demand curve. \$. Sales. Sales. \$. Law of Demand. When a good’s price is lower, consumers will buy more When a good’s price is higher, consumers will buy less.

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### CH 4 The Law of Demand

Define the law of demand

Substitutions

Analyze the demand curve

\$

Sales

Sales

\$

Law of Demand
• When a good’s price is lower, consumers will buy more
• When a good’s price is higher, consumers will buy less
• As prices go up, fewer and fewer people would be willing to pay for certain goods
• Law of Demand is based on 2 different patterns
• Substitution effect
• Income effect
Substitution Effect
• As the price of a good goes up, consumers become more likely to buy other goods
• Causes the amount of that good demanded to go down
• When a consumer reacts to a price increase by consuming less of that good and more of others
Income effect
• When prices go up, our \$ does not go as far as it used to
• Feels like you don’t have as much \$
• Consumption is measured by how much is bought, not how much it costs to buy a good
• Consumers may be spending more \$ on a good, but the consumption is going down
• Opposite is also true
• Prices go down, \$ for more things
Demand Schedule
• Demand - must be willing and able to buy a good at a specific price
• Demand Schedule - lists the quantity of a good a person would be willing to buy at a different prices

Quantity Demanded

Price

Quantity Demanded

Price

300

0.50

5

0.50

1.00

1.00

250

4

1.50

1.50

200

3

2.00

2

2.00

150

2.50

1

2.50

100

3.00

0

3.00

50

Demand Schedule

Market

Individual

Quantity Demanded

Price

Quantity Demanded

Price

300

0.50

5

0.50

3.00

1.00

1.00

250

4

\$

Demand

Curve

1.50

1.50

200

3

2.00

2.00

2

150

2.50

1

2.50

100

0.00

3.00

0

3.00

50

0

Quantity demanded

5

The Demand Curve
• Demand curve - Graphic representation of a demand schedule

Individual

Demand curve

3.00

\$

Demand

Curve

0.00

0

Quantity demanded

5

Demand curve
• Slopes down and to the right

Can be used to predict how buying habits will change with price change

Only good for a

Very specific set

Of market conditions

CH 4.2Shifts in the Demand Curve
• Difference between a change in quantity demanded and shift in curve
• Factors that would shift the curve
• How can the change in price of one good affect demand for a related good
Shifts in the Demand Curve
• Things can affect the demand of a good all the time
• To account for this Economists use the term ceteris paribus – “all other things constant” to show how only the price will change the quantity demanded

3.00

\$

Demand

Curve

0.00

0

Quantity demanded

5

Moving along the Demand Curve

When we hold all

Other factors the

Same, the shift

Is along the

Demand Curve

Price increase will

Result in less

demanded

Price decrease

Will result in more

demanded

Shifting the demand curve
• Drop ceteris paribus and allow other things to affect the curve
• Now the entire curve shifts

3.00

\$

3.00

3.00

\$

\$

0.00

0

Quantity demanded

5

More

demanded

0.00

0.00

0

Quantity demanded

5

0

Quantity demanded

5

Less demanded

What causes the shift
• Income
• Normal goods - goods that are demanded more when income increases
• Inferior goods - increase in income causes demand for this good to decrease
• With more \$ available, these are goods you would buy less of, or be less likely to buy
Customer Expectations
• Price fluctuations
• Demand and Price
• Price going to rise, current demand goes up
• Price going to fall, current demand drops
• Wait to buy the good
• Population
• Growing population needs more goods
• Increase in demand
• Baby boomers
• Now we need more nurses, doctors, nursing homes, houses in Florida and other retirement communities
• TV, Music, social trends
• Companies spend millions on advertising each year to get new customers and maintain old ones
Related Goods
• The demand for one good can affect the demand for another
• Complements- Two goods that are bought and used together
• Substitute - Goods used in place of other
4.3 Elasticity of Demand
• A measure of how consumers react to price changes
• What goods would you find money for no matter how much they cost?
• Gas, groceries, rent, prescription meds
• If the price of something were to rise just a little, would you buy less or none?
• Lotto tickets, jewelry
Elastic vs Inelastic
• Goods that you keep buying regardless
• Inelastic
• Gas, prescription meds
• Goods that you buy less of even if there is a small change
• Elastic
• Lotto tickets, jewelry, magazines

Original # - New #

________________

Original #

100

% change=

X

Calculating Elasticity

% change in quantity demanded

__________________________

% change in price

ELASTICITY =

Greater than 1 = Elastic

= 1, Unitary Elastic

Less than 1 (not negative!) = Inelastic

4-3

4

X 100 = 25

P

7

10 - 20

10

D

X 100 = 100

6

5

4

3

2

1

0

5

10

15

20

25

30

100

25

=

4.0

Elastic

p. 92

Factors affecting Elasticity
• Availability of substitutes
• If less subs are available, less likely to change demand
• If more subs are available, more potential to alter quantity demanded
• Relative importance
• Depending how important a good is to you
• Are you willing to spend more of your income on a good even if there is a price increase
Necessities vs. Luxuries
• Something that will always be purchased regardless of a price increase
• Milk vs steak
• Time
• Short term - inelastic
• Long term - elastic
Elasticity and Revenue
• Change in price will affect how much money a firm makes
• Total Revenue - Amount of money a firm makes by selling its goods and services
• Based on price and quantity sold
Pricing and Elasticity
• If a business owner knows if the demand is elastic:
• Raising prices will reduce total revenue
• Inelastic:
• Raising prices will increase total revenue

Price

Quantity Demanded

300

0.50

1.00

250

1.50

200

2.00

150

2.50

100

3.00

50

• If a business raises its prices too much, it could reduce its total revenue

150

250

300

300

250

Elastic

150

Available of substitutes will