Economics

Unit 3

Demand

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Do you create “demand”?

• Demand is more than just the desire to

purchase a product

• Wanting something is just not good

enough

• Two important things are necessary…

• You must be both willing and able to buy a

good or service

• You have to want it and have the money to

make the purchase

Two slightly different things…

• In economic terms demand is the amount

of a good or service that a consumer is

willing and able to buy at various possible

prices during a given time period.

• Another closely related term is quantity

demanded which is the amount of a good

or service that a consumer is willing and

able to buy at each particular price during

a given time period.

What makes us demand more or

less?

• In our free enterprise system, price is the

main variable that affects demand for a

good or service

• There is an inverse relationship between

the price of a good or service and the

quantity demanded for a good or service

• The lower the price the more we demand

• The higher the price the less we demand

There is really a Law?

• The inverse relationship has been

described as a law. The Law of Demand

• An increase in a good’s price causes a

decrease in the quantity demanded and a

decrease in price causes an increase in

quantity demanded

• You probably knew the concept without

knowing it was a law!

Purchasing Power

• The amount of money, or income, that

people have available to spend on goods

and services is called their purchasing

power

• As our purchasing power increases our

demand for goods and services tends to

increase too

• As our purchasing power decreases our

demand for goods and services tends to

decrease too

Changes

• Three concepts illustrate the changes that

occur as prices for goods and services go

up or down

• The Income Effect

• The Substitution Effect

• Diminishing Marginal Utility

Income Effect (Same Money,

Lower/Higher Prices)

• Any increase or decrease in consumers’

purchasing power caused by a change in

price is called the income effect

• As prices go down we feel like we have

more money and tend to buy more goods

and services with the same money

• As prices go up we feel like we have less

money and tend to buy less goods and

services with the same money

The Substitution Effect

• The tendency of consumers to substitute a

similar, lower-priced product for another

product that is relatively more expensive is

the substitution effect

• Hamburger instead of steak

• Margarine instead of butter

• Hill Country Fare instead of Green Giant

• Quantity demanded of the higher priced

item goes down/quantity demanded of the

lower priced item goes up

Marginal Utility

• In economics always associate the word

utility with usefulness or satisfaction

• In economics always associate the word

marginal with the value one

• As we consume additional units of a

product, our satisfaction with that

additional product typically rises

• One more...

Diminishing Marginal Utility

• Diminishing means that something goes

down or decreases

• Diminishing Marginal Utility is when the

extra usefulness (utility) of a product goes

down (diminishes) with the consumption of

each additional unit (margin).

• Lemonade Stand

• This explains why the demand for a

product is not limitless

Demand Schedules

• A easy way to show

the relationship

between the price of a

good or service and

the quantity that

consumers demand is

by showing it on a

demand schedule

• It illustrates that as

price goes up,

demand goes down

Demand Curves

• A demand curve illustrates the same thing as a demand

schedule, but plots the information on a graph

Both the

demand

curve and the

demand

schedule

shows the

price/demand

relationship

at a specific

time. We call

that a

snapshot in

time

Since the

timeframe

is the

same, the

only thing

that

changes

demand is

price

Sec. 2: Changes In Demand

• Time does not stand still and neither do markets

• The passage of time allows factors other than

price to influence demand. These other factors

are called determinants of demand

• Consumer tastes and preferences

• Market size

• Income

• Prices of related goods

• Consumer expectations

Non-Price Changes

• The determinants of demands listed on the

previous slide can cause the demand for a good

or service to increase or decrease at every price

level

Consumer Tastes and Preferences

• Recording artists come and go

• VHS movies to DVD movies to Blue Ray

movies to streaming

• Tube type TV’s to flat panel TV’s

• Wired internet to wireless internet

• Home phones to cell phones

• Demand for one product falls as demand

for another similar product increases

Market Size

• Market size is influenced by advertising

which can increase demand by attracting

new customers

• Foreign markets are developed that brings

in new customers

• Technological advances attract new

customers

Income

• As peoples income increases and they have

more money to spend, demand for goods and

services increase (raises/new jobs)

• As peoples income decreases and they have

less money to spend, demand for goods and

services decrease (layoffs/retirement/hours cut

back)

• This is different from the income effect because

that was brought on by a price change, not a

real income increase/decrease

Prices of Related Goods

• Goods that can be used to replace the

purchase of similar goods when prices rise

are called substitute goods

• When consumers switch to lower price

substitutes we call that the substitute

effect

• Butter/Margarine

• Steak/hamburger

More about related goods…

• Goods that are commonly used with other

goods are known as complimentary goods• Paint/paint brushes

• Automobiles/gasoline

• Guns/ammunition

• Hot Dogs/Hot Dog Buns

• Ink Jet Printers/print cartridges

• Peanut Butter/Jelly

• As demand for these goods increase the

demand for its complimentary good

increases at the same time

Consumer Expectations

• Sometimes demand increases/decreases based

only on an expectation that your income is going

to increase/decrease

• New job after graduation…

• You think you are getting a raise…

• Promotion…

• New company owners…

• Lay offs…

• You make changes even though the

increase/decrease has not actually happened

Sect. 3: Elasticity of Demand

• Elasticity of demand is the degree to which

changes in a good’s price affect the quantity

demanded by consumers

• Elasticity of demand can be either elastic or

inelastic

• Demand is said to be elastic if an

increase/decrease causes a corresponding

increase/decrease in sales of the product

• Manufacturers/Service Providers must consider

this before increasing the prices for their goods

or services. Will total revenue rise or fall?

Elastic Demand

• Elastic Demand exists when a change in a

good’s price causes an opposite change in

quantity demanded

• Goes both ways…..

• A increase in price causes a decrease in sales

• A decrease in price causes an increase in sales

• Tickets to movies/video rentals

What makes demand for some

goods elastic?

• The product is not a necessity

• There are readily available substitutes

• The product’s cost represents a large

portion of a consumers income

Inelastic Demand

• Inelastic demand exists when a change in a

good’s price has little impact on quantity

demanded

• A good usually has an inelastic demand if..

• The product is a necessity….

• There are few or no readily available

substitutes for the product…

• The products cost represents a small portion of

a consumers income…

• Salt, insulin...

Elasticity in

Specific & General Markets

• Are you looking at a big market or a

smaller segment of a market

• Price of gasoline in your neighborhood or

out on the interstate….

• Lots of grocery stores vs. only one or two

Measuring Elasticity

• Business can measure elasticity by

applying the total revenue test

• The total revenue test is the total income

that a business receives from selling it’s

product

• Measurement must be taken before/after a

change in price takes place

• Does the increase/decrease in price

increase/decrease total revenue?

Rising Prices vs. Demand

• If total revenue decreases following an

increase in price of the product/service,

demand for that product is generally said

to be elastic

• If total revenue increases following an

increase in price of the product/service,

demand for that product is generally said

to be inelastic

• Total Revenue = Quantity Sold X Price

Maximizing Total Revenue

• A provider of goods and services must find the

price that brings in the most revenue…

Notice that

the lowest

price is not

always the

price that

maximizes

revenue

References

• Economics: Texas Edition: 2016. McGraw Hill Education

• Holt Economics; Texas Edition: 2003, Holt, Rinehart and

Winston