Unit 2: Supply, Demand, and Consumer Choice 1

Connection to Circular Flow Model 1.Do individuals supply or demand? 2.Do business supply or demand? 2

DEMAND DEFINED What is Demand? Demand is the different quantities of goods that consumers are willing and able to buy at different prices. (Ex: Bill Gates is able to purchase a Ferrari, but if he isn’t willing he has NO demand for one) What is the Law of Demand? The law of demand states There is an INVERSE relationship between price and quantity demanded 3

LAW OF DEMAND As Price Falls… …Quantity Demanded Rises As Price Rises… …Quantity Demanded Falls Price Quantity Demanded 4

Example of Demand I am willing to sell several A’s in AP Economics. How much will you pay? PriceQuantity Demanded Demand Schedule 5

Why does the Law of Demand occur? The law of demand is the result of three separate behavior patterns that overlap: 1.The Substitution effect 2.The Income effect 3.The Law of Diminishing Marginal Utility We will define and explain each… 6

If the price goes up for a product, consumer but less of that product and more of another substitute product (and vice versa) 1. The Substitution Effect If the price goes down for a product, the purchasing power increases for consumers - allowing them to purchase more. 2. The Income Effect Why does the Law of Demand occur? 7

Utility = Satisfaction We buy goods because we get utility from them The law of diminishing marginal utility states that as you consume more units of any good, the additional satisfaction from each additional unit will eventually start to decrease In other words, the more you buy of ANY GOOD the less satisfaction you get from each new unit. Discussion Questions: 1.What does this have to do with the Law of Demand? 2.How does this effect the pricing of businesses? 3. Law of Diminishing Marginal Utility Why does the Law of Demand occur? U-TIL-IT-Y 8

Change N/A $54 $33 $15 $10 $5 Can you see the Law of Diminishing Marginal Utility in Disneyland’s pricing strategy?

The Law of Diminishing Marginal Utility 10

Graphing Demand 11

The Demand Curve A demand curve is a graphical representation of a demand schedule. The demand curve is downward sloping showing the inverse relationship between price (on the y-axis) and quantity demanded (on the x-axis) When reading a demand curve, assume all outside factors, such as income, are held constant. (This is called ceteris paribus) Let’s draw a new demand curve for cereal… 12

GRAPHING DEMAND Q o $ Price of Cereal Quantity of Cereal Demand Schedule Draw this large in your notes 13 Price Quantity Demanded $510 $420 $330 $250 $180

GRAPHING DEMAND Q o $ Price of Cereal Quantity of Cereal Demand Schedule Price Quantity Demanded $510 $420 $330 $250 $180 Demand

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The Demand Curve

Change in Demand vs. Change in Quantity Demanded

Shifts of Demand There are several “shifters” of demand besides price, which change demand. Changes in a shifter cause a Change in Demand. If demand has increased, it has shifted to the right. At any price, consumers wish to buy more. If demand has decreased, it has shifted to the left. At any price, consumers wish to buy less.

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Shifts of Demand 1. Prices of related goods i. Substitute goods (those that can be used in place of each other): Price of substitute and demand for the other good are directly related. If the price of Nike shoes rises, the demand for New Balance shoes should shift to the right. ii. Complementary goods (those that are used together like tennis balls and rackets): When goods are complementary, there is an inverse relationship between the price of one and the demand for the other. If the price of tennis rackets rises, demand for tennis balls will shift to the left.

Shifts of Demand 2. Income i. Normal goods More income leads to an increase in demand; less leads to decrease in demand for most goods and services. Steak is a normal good. So are textbooks, running shoes, and iPods. ii. Inferior goods For a few goods, more income leads to a decrease in demand. Chicken is an inferior good because of the price. City bus tickets are. So are second- hand clothing and store-brand food items.

Shifts of Demand 3. Tastes A favorable change in tastes leads to an increase in demand; an unfavorable change to a decrease. Example Demand for a sport team’s apparel increases when the team is winning.

Shifts of Demand 4. Expectations Consumers have expectations about future prices, product availability, and income, and these expectations can shift demand. Example If I expect the price of gas to decrease next week, my demand for gas will decrease this week. I will wait for the price to fall. Example If I take a new job and expect my salary to rise next month, I may increase my demand for a new suit today.

Shifts of Demand 5. Number of buyers—the more buyers lead to an increase in demand; fewer buyers lead to decrease. Example Demand for prescription drugs has increased as the population has grown older. Example Demand for infant formula would decrease if families had fewer babies.

Shifts of Demand-Review The forces of demand are all the factors that shift the curve Related Goods Income Tastes Expectations Number of Buyers

Individual Demand & MARKET Demand

Where do you get the Market Demand? Q Billy PriceQ Demd $51 $42 $33 $25 $17 JeanOther Individuals PriceQ Demd $50 $41 $32 $23 $15 PriceQ Demd $59 $417 $325 $242 $168 PriceQ Demd $510 $420 $330 $250 $180 Market 3 P Q 2 P Q 25 P Q 30 P $3 DDDD