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Chapter 2: Demand & Supply. Agenda (Game Plan) n Markets & Circular Flow Diagram n What is demand? n The law of demand n The demand curve n Determinants.

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Presentation on theme: "Chapter 2: Demand & Supply. Agenda (Game Plan) n Markets & Circular Flow Diagram n What is demand? n The law of demand n The demand curve n Determinants."— Presentation transcript:

1 Chapter 2: Demand & Supply

2 Agenda (Game Plan) n Markets & Circular Flow Diagram n What is demand? n The law of demand n The demand curve n Determinants of demand n Change in demand vs. change in quantity demanded n The law of diminishing marginal utility n Elasticity of Demand

3 What is a Market? n Any network that brings buyers and sellers together so they can exchange goods and services n Doesn’t have to be a physical place, but can be done over the internet, phone or fax n Exists wherever supply and demand determine the price and quantity of goods and services sold n Some markets are Global (Oil) others are local (Hot dogs)

4 The Circular Flow Diagram n Demonstrates how households & businesses interact n Households are buyers (concept of demand) n Businesses are sellers (concept of supply)

5 Circular Flow Between Businesses and Households Business Households Consumer Goods & Services Money (household income) Economic Resources (land, labour, Capital & entrepreneurial skills) Money (consumer spending)

6 Demand: The Consumer Side n Is the quantities of a good or service that buyers are willing and able to purchase at various prices n Demand schedule shows the various prices and quantity demanded at each price n Economists consistently will gather data and put it into a schedule n Then to make it visually easier to understand, put the schedule into graph form

7 The Law of Demand n Law of Demand: An increase in price will cause a decrease in quantity demanded (and vice versa) n A decrease in price will cause an increase in quantity demanded

8 The Demand Curve Price Quantity D P$P$ Q0

9 The Law of Demand n There is an indirect relationship between price (P) and quantity demanded (Qd) n P Qd

10 Change In Demand (D) vs. Change in Quantity Demanded (Qd) n A change in quantity demanded (QD) occurs when there is a change in price (Ceteris Paribus) n This is represented by a move along the demand curve. n A change in demand (D) occurs when there is a change in a demand determinant n This is represented by a shift of the demand curve

11 Effect of an Increase in Demand Price Level Quantity D Q 0 D1D1D1D1 P$P$

12 Effect of a Decrease in Demand Price Level Quantity D Q 0 D0D0D0D0 P$P$

13 Determinants of Demand 1. Number of buyers  More buyers = more demand & fewer buyers = less demand 2. Income effect  For normal products increased income = increased demand, For inferior products (e.g. canned meat) increased income = decreased demand 3. Prices of Substitute Products  A price increase (decrease) in one product causes an increase (decrease) in the demand for its substitute Eg: Butter/Margarine

14 Determinants of Demand 4. Prices of Complementary Products A price increase (decrease) in one product causes a decrease (increase) in the demand for its substitute Eg: Cars and gas, DVD players & DVD’s 5. Consumer Preferences  A change in consumers tastes and preferences also affects demand. Eg. Nutrition, fashion, safety. 6. Consumer Expectations  Expectation of future price changes will alter current demand (e.g. gas price increases the immediate future will cause consumer to fill their tanks earlier)

15 Law of Diminishing Marginal Utility n Law of Diminishing Marginal Utility  satisfaction diminishes with increased consumption. Therefore must decrease price to increase consumption n Each additional unit of a good or service that is consumed brings less satisfaction or “utils” than the previous unit consumed n This helps explain why the demand curve is downward sloping n Measurement in utils of human satisfaction when consuming products n Consume up to and including the point where your satisfaction level is equal between two products MU / P1 = MU / P2

16 Elasticity of Demand n Shows the responsiveness of the quantity demanded to a change in price n P x Qd = TR (total revenue) n Elastic Demand n P < Qd n Inelastic Demand n P > Qd n Unitary Demand n P = Qd

17 Factors Affecting Price Elasticity of Demand Portion of Consumer Incomes Access to Substitutes Necessities vs. Luxuries Time

18 FACTORS AFFECTING ELASTICITY OF DEMAND 1. Portion of Consumer Incomes – Products taking up larger portions of income are more responsive (elastic) to price changes (stereo, rent) – Smaller purchases tend to be more inelastic (bread, milk, salt) 2. Access to Substitutes – The demand for products with close substitutes will be more elastic (e.g. margarine and butter)

19 FACTORS AFFECTING ELASTICITY OF DEMAND 3. Necessities vs. Luxuries – Consumers usually purchase similar quantities of basic necessities (such as milk, eggs, bread etc) regardless of price. Therefore, demand is inelastic. – Luxury items (such as vacations, jewelry, boats) tend to be elastic. 4. Time – Demand tends to be more elastic over time. – Eg. Petroleum, natural gas, electricity

20 Applications n Homework P #1-7 n Determinant of Demand Exercise (blue sheet) n Article & Questions: Electronic Gadgets


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