Understanding Demand in Market Systems

1. Chapter 4 Demand Section 1: Understanding Demand

2. In a market system, the interaction of buyers & sellers determines the prices of most goods as well as what quantity of a good will be produced

3. Buyers demand goods, sellers supply those goods • Demand- desire to own something & the ability to pay for it

4. The Law of Demand • When a good’s price is lower, consumers will buy more • The law of demand is the result of not one pattern of behavior, but of two separate patterns that overlap • Substitution effect & income effect

5. Together they explain why an increase in price decreases the quantity purchased • These two effects describe different ways that a consumer can change his or her spending patterns for other goods.

6. The Substitution Effect • When the price rises, consumers have an incentive to buy an alternative as a substitute • Causes a drop in demand

7. Takes place when a consumer reacts to a rise in the price of one good by consuming less of that good & more of a substitute good • Can also apply to a drop in prices

8. The Income Effect • The income effect happens when a person changes his or her consumption of goods and services as a result of a change in real income. • When the price goes up, you can no longer afford to buy the same combination of goods & you must cut back your purchases of some goods

9. Economists measure consumption in the amount of a good that is bought, not the amount of money spent to buy it • When the price goes up, the quantity demanded goes down • Income effect leads to the law of demand

10. A Demand Schedule • The law of demand explains how the price of any item affects the quantity demands of that item

11. Demand Schedules Individual Demand Schedule Market Demand Schedule Price of a slice of pizza Quantity demanded per day 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 The Demand Schedule

12. Understanding Demand • To have demand for a good, you must be willing & able to buy it at the specified price • A demand schedule is a table that lists the quantity of a good that a person will purchase at each price

13. Market Demand Schedule • Shows quantities demanded at each price by all consumers • At higher prices the quantity demanded is lower • Market schedule lists larger quantities demanded

14. The Demand Graph • A demand curve is a graphic representation of a demand schedule • How do they create it? • Transfer numbers from a demand schedule to a graph, label the vertical axis with the lowest possible prices at the bottom & the highest at the top

15. Quantities demanded on the horizontal axis with the lowest possible quantity at the left & highest at the right • Connecting the points creates a demand curve

16. Reading a Demand Curve • Graph shows only the relationship between price & quantity • Demand curve slopes downward to the right • As price decreases, quantity demanded increases

17. Market Demand Curve 3.00 2.50 2.00 1.50 1.00 .50 0 Price per slice (in dollars) 200 250 350 300 0 50 100 150 Slices of pizza per day The Demand Curve • When reading a demand curve, assume all outside factors, such as income, are held constant. Demand

18. Limits of a Demand Curve • The market demand curve can be used to predict how people will change their buying habits when the price of a good rises or falls • Only accurate for one very specific set of market conditions