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The Economics of Demand

The Demand Curve Elasticity of Demand Changes in Demand

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Demand Why are newspapers sold in vending

machines that allow you to take more than one copy?

How much do you eat when you can eat all you want?

What cures ‘spring fever’? What economic principle is behind the

saying, “Been there, done that”? Why do higher cigarette taxes cut smoking

by teens more than by other age groups?

Consider

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The Demand Curve Explain the law of demand Interpret a demand schedule and

demand curve

Objectives

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The Demand Curve demand law of demand marginal utility law of diminishing marginal utility demand curve quantity demanded individual demand market demand

Key Terms

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Demand

Demand indicates how much of a product consumers are both willing and able to buy at each possible price during a given period, other things remaining constant.

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Law of Demand

The law of demand says that quantity demanded varies inversely with price, other things constant. Thus, the higher the price, the smaller the quantity demanded.

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Law of Demand Demand, wants, and needs  Substitution effect

The change in the relative price (the price of one good relative to the prices of other goods) causes the substitution effect

If all prices changed by same margin, there would be no substitution effect

Income effect Money income – the number of dollars you receive per period Real income – measure in terms of how many goods and services

you can buy

Diminishing marginal utility Marginal utility – additional satisfaction you derive from each item Law of marginal utility you derive from each additional item

consumed decreases as your consumption increases (example: pizza slices)

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Demand Schedule and Demand Curve Demand versus quantity demanded

Individual demand

Market demand

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Demand SchedulePrice Quantity Demanded

per Pizza per Week (millions)

a $15 8

b 12 14

c 9 20

d 6 26

e 3 32

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8 14 20 26 32Millions of pizzas per week

$15

12

9

6

3

0

Pri

ce p

er p

izza

Demand Curve for Pizzaa

b

c

d

e

D

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$12

8

4

1

(c) Chris

$12

8

4

1 2

(b) Brianna

$12

8

4Pri

ce

1 2 3 Pizzas (per week)

(a) Hector

Individual Demand for Pizzas

dH dB dC

12

$12

8

4Pri

ce

1 2 3 Pizzas (per week)

(d) Market demand for pizzas

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Market Demand for Pizzas

dH dB dC D+ + =

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Elasticity of Demand Compute the elasticity of demand and

explain its relevance. Discuss factors that influence

elasticity of demand.

Objectives

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Computing the Elasticity of Demand Elasticity of demand measures the

percentage change in quantity demanded divided by percentage change in price.

Elasticity of

demand

=

Percentage change in quantity demanded

Percentage change in price

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Computing Elasticity of Demand Elasticity values

>1 it is elastic Percentage change in price will result in larger percentage

change in the quantity demanded =1 it is unit-elastic <1 it is inelastic Demand is usually more elastic at higher prices and

less elastic with lower prices Elasticity and total revenue

Price x’s quantity demanded at that price

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8 14 20 26 32Millions of pizzas per week

$15

12

9

6

3

0

Pric

e pe

r pi

zza

The Demand for Pizza

D

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Determinants of Demand Elasticity Availability of substitutes

The greater the availability of substitutes for a good, the greater the good’s elasticity of demand

Share of consumer’s budget spent on the good Increase in prices reduced the demand because people are not

both willing and able to purchase @ higher prices A matter of time

The longer the adjustment period, the greater the consumer’s ability to substitute

Some elasticity estimates The elasticity of demand is greater in the long run because

consumers have more time to adjust

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50 75 95100 Millions of gallons per day0

$1.25

1.00

Pric

e pe

r gal

lon Dy

Dm

Dw

Demand Becomes More Elastic Over Time

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Selected Elasticities of Demand

ProductProduct Short RunShort Run Long RunLong Run

Electricity (residential) 0.1 1.9

Air travel 0.1 2.4

Medical care and hospitalization 0.3 0.9

Gasoline 0.4 1.5

Movies 0.9 3.7

Natural gas (residential) 1.4 2.1

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Other Determinants of Demand Consumer Income The prices of related goods The number and composition of

consumers Consumer expectations Consumer tastes

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Changes in Consumer Income If income ↑, consumers willing and

able to buy more which ↑ demand Demand curve shifts to the right

Two categories of goods: Normal goods – demand increases as

money income increases Inferior goods – demand decreases as

money income increases Examples: used clothing, bus rides, etc.

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Changes in the Prices of Related Goods Substitutes

Decrease in price of one item will reduce the demand for a substitute Example: Tacos and Pizza

Complements Certain goods used together

Example: airline tickets and car rentals A decrease in the price of one shifts the

demand of the other rightward

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Changes in Prices of Related Goods (cont) Changes in size or composition of the

population will increase demand and shift the curve to the right

Changes in consumer expectations can shift the demand curve to the left or the right

Changes in consumer tastes Tastes are your likes and dislikes as a consumer

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Movement along the Curve Movement vs. Shift

A change in price, causes a movement along the demand curve, changes the quantity demanded

A change in one of the determinants of demand other than price causes a shift of a demand curve

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Extensions of Demand Analysis Role of time

Your willingness to pay more for time-saving goods depends on the opportunity cost of your time!