Chapter 4 Section 1 Understanding how Demand works!

D E M A N D Objectives: Explain the Law of Demand. Understand how the substitution effect and the income effect influence decisions. Create a demand schedule for an individual and a market. Interpret a demand graph using demand schedules.

D E M A N D Different ways to answer the 3 economic questions. What to produce? How much to produce? Who gets what?

D E M A N D United States…allocate most goods through a market system. Interaction of buyers and sellers determine the prices of goods as well as the quantity that is produced.

D E M A N D What is Demand???????? It is the desire to own something and the ability to pay for it.

D E M A N D What is the Law of Demand? When a good’s price is lower, consumers will buy more of it. When price is higher, consumers will buy less of it.

D E M A N D Law of Demand is a result of 2 patterns of behavior: Substitution Effect Income Effect 2 different ways consumers can change their spending patterns.

D E M A N D The Substitution Effect…. When consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

D E M A N D Example: Pizza Substitutes - - Tacos, Salads, etc… This will cause a drop in the amount of pizza demanded.

D E M A N D Substitution Effect can also apply to a drop in prices. IF pizza prices drop, more pizza will be bought than other substitutes.

D E M A N D You feel like you have less money…. The Income Effect…. The change in consumption resulting from a change in real income. Example: When prices of movie tickets, shoes, pizza increase… our limited budget won’t buy as much as it used to. You feel like you have less money….

D E M A N D Difference between Substitution and Income Effect Income Effect– you cut back on your purchases without substituting another product.

D E M A N D Economists measure CONSUMPTION is the amount of a good that is bought, not the amount of money spent to buy that good. You are spending more and consuming less!

D E M A N D In a sense…. The income effect leads to the law of demand!

D E M A N D Demand Schedule… A table that lists the quantity of a good a person will buy at each different price. It explains how the price of any item affects the quantity demanded of that item.

D E M A N D

D E M A N D To have demand for a good…. You must be willing and able to buy it at the specified price. Want a Hummer H3, but do not have the means to pay for it or do not have the desire to pay for it.

D E M A N D Market Demand Schedule…. Shows the quantities demanded at each price by ALL consumers in the market. Demand Graph….. Is a graphic representation of a demand schedule.

D E M A N D Demand Graph…. Vertical Axis Horizontal Axis Lowest possible price at the bottom and highest possible price at the top. Horizontal Axis Quantity Demanded with the lowest possible quantity at the left and the highest possible quantity at the right. Demand Curve is always labeled with a D.

                        D E M A N D Demand Graph

D E M A N D The graph shows the relationship between the price of this good and the quantity that a person (or market) will purchase. Demand Curve is always DOWNWARD sloping to the RIGHT! As price decreases…the quantity demanded increases.

D E M A N D Prices of Related Goods The demand for one good can be affected by a change in the demand for another good. Two types Complements Substitutes

D E M A N D Complements Two goods that are bought and used together. Example: Camera & film Peanut Butter & Jelly

D E M A N D Substitutes: Are goods used in place of one another. Example: Skis and Snowboards Crayons and Markers

D E M A N D An Independent Good An item that is neither a substitute nor a complement. Examples: Coffee Cup = it could be a Table Desk = it could be a Black Board

D E M A N D Complete the assignment below and turn in for a grade. Using the 7 examples on the next slide…. Give an example of…. A. a Substitute B. a Complement C. an Independent Good

Homework Assignment 1. Toothpaste Item Substitute Complement Independent Good 1. Toothpaste

D E M A N D 1. Toothpaste 2. Computers 3. Pencil 4. Coffee 5. Dishwashing Soap 6. Chalk Board 7. Bicycle