The Demand for Goods

1. The Demand for Goods Chapter 5

2. Determinants of Demand • What leads us to buy some goods while rejecting others?

3. The Sociopsychiatric Explanation • In Freud’s view, higher levels of consumption satisfy our basic drives for security, sex, and ego gratification. • According to some sociologists, consuming more is an expression of identity that provokes recognition or social acceptance.

4. Affluent Teenagers

5. The Economic Explanation • In explaining consumer behavior, economists focus on the demand for goods and services. • Demand is the willingness and ability to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus.

6. The Economic Explanation • An individual’s demand for a product is determined by: • Tastes—desire for this and other goods. • Income—of the consumer. • Expectations—for income, prices, tastes. • Other goods—their availability and prices.

7. The Demand Curve • Economists are interested in how consumer tastes affect consumption decisions.

8. Utility Theory • Utility is the pleasure or satisfaction obtained from a good or service. • The more pleasure a product gives us, the higher the price we’re willing to pay for it.

9. Total vs. Marginal Utility • Total utility is the amount of satisfaction obtained from entire consumption of a product.

10. Total vs. Marginal Utility • Marginal utility is the change in total utility obtained by consuming one additional (marginal) unit of a good or service.

11. TOTAL UTILITY MARGINAL UTILITY Negative marginal utility Total utility Total Utility Marginal Utility Rising total utility Diminishing marginal utility 0 1 2 3 4 5 6 0 1 2 3 4 5 6 Quantity of Popcorn (boxes per show) Quantity of Popcorn (boxes per show) Total vs. Marginal Utility

12. Diminishing Marginal Utility • According to the law of diminishing marginal utility, the marginal utility of a good declines as more of it is consumed in a given time period. • As long as marginal utility is positive, total utility must be increasing.

13. Diminishing Marginal Utility • According to the law of diminishing utility, each successive unit of a good consumed yields less additional utility. • Eventually, additional quantities of a good yield increasingly smaller increments of satisfaction.

14. TOTAL UTILITY MARGINAL UTILITY Negative marginal utility Total utility Total Utility Marginal Utility Rising total utility Diminishing marginal utility 0 1 2 3 4 5 6 0 1 2 3 4 5 6 Quantity of Popcorn (boxes per show) Quantity of Popcorn (boxes per show) Diminishing Marginal Utility

15. Price and Quantity • Tastes, through marginal utility, tells us how much we desire particular goods. • Price tell us how much of a good we will buy.

16. Price and Quantity • We make the ceteris paribus assumption when we look at the relationship between the price of the good and the amount we’re willing to buy. • Ceterisparibus - The assumption of nothing else changing.

17. Price and Quantity • The more marginal utility a product delivers, the more a consumer is willing to pay, ceteris paribus. • As the marginal utility of a good diminishes, so does our willingness to pay.

18. Price and Quantity • According to thelaw of demand, the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.

19. Price and Quantity • Thedemand curve describes the quantities of a good a consumer is willing and able to buy t alternative prices in a given time period,ceteris paribus. • The law of demand is illustrated by a downward-sloping demand curve.

20. $0.55 A 0.50 B 0.45 C 0.40 D 0.35 E 0.30 PRICE (per ounce) F 0.25 G 0.20 H 0.15 I 0.10 J 0.05 0 4 8 12 16 20 24 28 32 Quantity Demanded (Ounces per show) Individual’s Demand Schedule and Curve The willingness to pay diminishes along with marginal utility

21. Price Elasticity • The response of consumers to a change in price is measured by the price elasticity of demand.

22. Price Elasticity • Theprice elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.

23. Price Elasticity • The price elasticity of demand (E) is always negative because quantity demanded decreases when prices increase. • The absolute value of the price elasticity of demand will always be greater than zero.

24. Computing Price Elasticity • To ensure consistency, average quantity and average price (before and after) is used in the calculation.

25. Computing Price Elasticity

26. Elastic vs. Inelastic Demand • If E is larger than 1, demand is elastic. • Consumer response is large relative to the change in price. • If E is less than 1, demand is called inelastic. • Consumers aren’t very responsive to price changes. • If E equals 1, demand is unitary elastic.

27. Elasticity Estimates

28. Extremes of Elasticity • A horizontal demand curve means that demand is perfectly elastic. • Any price increase would cause demand to fall to zero. • A vertical demand curve means that demand is completely inelastic. • Quantity demanded will not change regardless of the price change.

29. Completely elastic (E = ) Completely inelastic (E = 0) p2 p2 Price Price p1 p1 q1 q1 0 0 Quantity Quantity Extremes of Elasticity

30. Determinants of Elasticity • The price elasticity of demand is influenced by all of the determinants of demand. • Four factors are particularly worth noting: • Necessities vs. luxuries. • Availability of substitutes. • Relative price (to income). • Time.

31. Necessities vs. Luxuries • Demand for necessities is relatively inelastic • Necessities are goods that are critical to our everyday life,

32. Necessities vs. Luxuries • Demand for luxury goods is relatively elastic. • Luxuries are goods we would like to have but are not likely to buy unless our income jumps or the price declines sharply.

33. Availability of Substitutes • The greater the availability of substitutes, the higher the price elasticity of demand.

34. Relative Price (to income) • The higher the price in relation to a consumer’s income, the higher the elasticity of demand. • The price elasticity of demand declines as price moves down the demand curve.

35. Time • The long-run price elasticity of demand is higher than the short-run elasticity. • Consumers are better able to change their buying habits over the long-run that in the short-run.

36. Price Elasticity and Total Revenue • There is a relationship between price elasticity and total revenue. • Total revenue – The price of a product multiplied by the quantity sold in a given time period: p x q. Total revenue = Price X Quantity sold

37. Price Elasticity and Total Revenue • A price hike increases total revenue only if demand in inelastic (E < 1). • A price hike reduces total revenue if demand is elastic (E > 1). • A price hike does not change total revenue if demand is unitary elastic (E = 1).

38. Price Elasticity and Total Revenue

39. Price Elasticity and Total Revenue $0.55 0.50 B 0.45 C Higher prices will reduce total revenue if E > 1 0.40 0.35 0.30 PRICE (per ounce) 0.25 0.20 0.15 0.10 0.05 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 QUANTITY DEMANDED (ounces per show)

40. Changing Value of E • Price elasticity changes along a demand curve. • The impact of a price change on total revenue depends on the (changing) price elasticity of demand.

41. The demand curve $8 7 Elastic E > 1 6 5 Unit elastic E = 1 PRICE 4 3 2 1 Inelastic E < 1 0 10 20 30 40 50 60 70 80 90 100 110 Total revenue E = 1 $225 200 175 150 Elastic E > 1 Inelastic E < 1 125 TOTAL REVENUE 100 75 50 25 0 10 20 30 40 50 60 70 80 90 100 110

42. Other Elasticities • Other factors affect consumption behavior.

43. Shifts vs. Movements • When the price changes, the outcome is a movement along the unchanged demand curve. • When the underlying determinants of demand change, the entire demand curve shifts.

44. Income Elasticity • An increase in consumer income will cause a rightward shift in demand. • Consumers will now purchase more at any price than they did prior to the increase in income.

45. Shift Income Elasticity F N 0.25 Price of Popcorn (dollars per ounce) D2 (after income rise) D1(before income rise) 0 12 16 Quantity of Popcorn (ounces per show)

46. Income Elasticity • Income elasticity of demand is the percentage change in quantity demanded divided by percentage change in income.

47. Computing Income Elasticity • As with price elasticity, income elasticity is computed using average values for the changes in quantity and income.

48. Normal vs. Inferior Goods • A normal good has an income elasticity of demand greater than zero. • Anormal good is a good for which demand rises when income rises.

49. Normal vs. Inferior Goods • An inferior good has an income elasticity of demand less than zero. • An inferior good is a good for which demand decreases when income rises.

50. Cross-Price Elasticity • A change in the price of one good affects the demand for another. • The decision to buy a good depends on the prices of substitutes and complements of that good.