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Understanding Demand and the Demand Curve

Learn about the concept of demand and how it affects the price and quantity of goods. Explore the factors that influence demand and how to graph a demand curve.

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Understanding Demand and the Demand Curve

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  1. Ch. 4 Demand Before we begin, there’s a couple of important things to recall :

  2. What is a “market”? • A market is created when______ • Of their own free will, each side willingly ______ • Point #1: The interaction b/t buyers and sellers determines the price of most goods and how much will be produced

  3. Recalling Adam Smith & the “invisible hand” • Goods & services produced in a market economy are the result of Supply and Demand • If people want (demand) a particular good/service, someone will likely supply it to make a profit • So…let’s take a look at DEMAND

  4. What is “demand”?? • Demand exists ONLY when the following are true: 1. Desirefor the item 2. Abilityto pay for it 3. Willingto pay for it

  5. The Law of Demand • As the price of a good increases, quantity demanded decreases • Similarly, as the price of a good decreases, quantity demanded increases • In other words: when price goes up, we buy less…when price goes down, we buy more Price QD QD Price

  6. Why is this true? • 2 separate behaviors overlap: A. the substitution effect and B. the income effect

  7. The Substitution Effect occurs when we react to a price increase by consuming less of that good… and more of other goods that satisfy the same basic need The Income Effect The qty of an item you consume changes if its price changes but your income does not

  8. An individual demand schedule is a table that lists the quantity of a good a person will buy at each different price. A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price. 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

  9. 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 • A demand curve is a graphical representation of a demand schedule. • When reading a demand curve, assume all other factors in the market (income, population, etc.) remain constant. * • *important point! Demand

  10. Limits of a Demand Curve • Can only be used to predict how people’s buying habits might change when price and ONLY price changes • To put it another way: A demand curve is accurate for 1 specific set of market conditions

  11. Now…it’s your turn: Graphing a market demand curve: • Horizontal axis shows quantity w/precise labeling • Vertical axis shows price w/precise labeling • Label lines, not spaces • Be consistent in your “scaling” • Provide specific title • Write clearly and neatly!

  12. Demand for Red Wine (bottles) PriceQty. Demanded $15.00 100 $14.00 150 $13.00 200 $12.00 300 $11.00 400 $10.00 500 $ 9.00 700 $ 8.00 1,000 $ 7.00 1,400 $ 6.00 2,000 Label your demand curve D1

  13. Sec. 2 Shifts of the Demand Curve Objectives: Sort out the following… (not necessary to write these down!) • What is the difference between a “change in quantity demanded” and a “change in demand” ? • What factors can cause a “change in demand” ? • How does the change in the price of one good affect the demand for a related good?

  14. Shifts in Demand • Ceteris paribus is a Latin phrase economists use meaning “all other things held constant.” • A demand curve is accurate only as long as the ceteris paribus assumption is true. • If for some reason qty demanded at EACH and EVERY price changes, the entire demand curve will shift (move) to the left or right • When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts.

  15. What Causes a Shift in Demand? • Several factors can lead to a change in demand: 1. Income Changes in consumers’ incomes affect demand: “normal good”:a good consumers demand more of when their incomes increase. “inferior good”:good that consumers demand less of when their income increases. 2. Consumer Expectations Whether or not we expect a good to increase or decrease in price in the future greatly affects our demand for that good today. 3. Population Changes in the size of the population also affects the demand for most products. 4. Consumer Tastes and Advertising Advertising plays an important role in “helping us to know what we want” and therefore influences demand

  16. Complements are two goods that are bought and used together. Example: Substitutes are goods used in place of one another. Example: Prices of Related Goods The demand curve for one good can be affected by a change in the demand for another good.

  17. Major Health Story! • It has just been proventhat consuming red wine will dramatically speed up the aging process. Studies prove that those who drank 5 glasses of wine per week with their dinner will shorten their lives by as much as 15 years.

  18. How will this news affect the demand curve for red wine??? (what will happen to the curve?) • Now…construct a new demand curve for red wine using the following figures: (label it D2)

  19. Demand for Red Wine (bottles) PriceQty. Demanded $15.00 0 $14.00 50 $13.00 50 $12.00 100 $11.00 200 $10.00 300 $ 9.00 500 $ 8.00 800 $ 7.00 1100 $ 6.00 1600 Label this curve D2

  20. Sec. 3 Elasticity of Demand • What is “elasticity” of demand? • What factors affect elasticity? • How does a business use elasticity and total revenue to make decisions?

  21. Demand for a good that doesn’t change much despite a price change is Inelastic The more demand reacts to a change in price, the more Elastic it is What Is Elasticity of Demand? Elasticity of demand measures how much qty. demanded changes when there is a change in price.

  22. Factors Affecting Elasticity • Several different factors can affect the elasticity of demand for a certain good. 1. Availability of Substitutes Few substitutes for a good? demand will not likely decrease as price increases. The opposite is also usually true. (eg heart surgery) 2. Necessities versus Luxuries Which would most likely be more elastic? 3. Relative Importance How much of your budget you spend on the good? (eg: even if pepper doubles in price, you likely do not buy more) 4. Change over Time Demand sometimes becomes more elastic over time because people can eventually find substitutes. (eg: gasoline)

  23. Elasticity and Revenue The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income. • total revenue:total amount of money the company receives from selling its goods or services. • Firms need to be aware of the elasticity of demand for the good or service they are providing. • If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.

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