The Economics of Demand CONTEMPORARY ECONOMICS 3/31/2017 The Economics of Demand The Demand Curve Elasticity of Demand Changes in Demand LESSON 4.1

Consider Demand Why are newspapers sold in vending machines that allow you to take more than one copy? How much do you eat when you can eat all you want? What cures ‘spring fever’? What economic principle is behind the saying, “Been there, done that”? Why do higher cigarette taxes cut smoking by teens more than by other age groups?

Explain the law of demand Interpret a demand schedule and demand curve Objectives The Demand Curve Explain the law of demand Interpret a demand schedule and demand curve

Key Terms The Demand Curve demand law of demand marginal utility law of diminishing marginal utility demand curve quantity demanded individual demand market demand

Demand Demand indicates how much of a product consumers are both willing and able to buy at each possible price during a given period, other things remaining constant.

Law of Demand The law of demand says that quantity demanded varies inversely with price, other things constant. Thus, the higher the price, the smaller the quantity demanded.

Law of Demand Demand, wants, and needs Substitution effect The change in the relative price (the price of one good relative to the prices of other goods) causes the substitution effect If all prices changed by same margin, there would be no substitution effect Income effect Money income – the number of dollars you receive per period Real income – measure in terms of how many goods and services you can buy Diminishing marginal utility Marginal utility – additional satisfaction you derive from each item Law of marginal utility you derive from each additional item consumed decreases as your consumption increases (example: pizza slices)

Demand Schedule and Demand Curve Demand versus quantity demanded Individual demand Market demand

Demand Schedule a $15 8 b 12 14 c 9 20 d 6 26 e 3 32 Price Quantity Demanded per Pizza per Week (millions) a $15 8 b 12 14 c 9 20 d 6 26 e 3 32

Demand Curve for Pizza 8 14 20 26 32 Millions of pizzas per week $15 12 9 6 3 Price per pizza a b c d e D

Individual Demand for Pizzas $12 8 4 Price 1 2 3 Pizzas (per week) (a) Hector $12 8 4 1 2 (b) Brianna $12 8 4 1 (c) Chris d H d B d C

Market Demand for Pizzas $12 8 4 Price 1 2 3 Pizzas (per week) (d) Market demand for pizzas 6 d H B C D + =

CONTEMPORARY ECONOMICS 3/31/2017 Objectives Elasticity of Demand Compute the elasticity of demand and explain its relevance. Discuss factors that influence elasticity of demand. LESSON 4.1

Computing the Elasticity of Demand CONTEMPORARY ECONOMICS 3/31/2017 Computing the Elasticity of Demand Elasticity of demand measures the percentage change in quantity demanded divided by percentage change in price. Elasticity of demand = Percentage change in quantity demanded Percentage change in price LESSON 4.1

Computing Elasticity of Demand Elasticity values >1 it is elastic Percentage change in price will result in larger percentage change in the quantity demanded =1 it is unit-elastic <1 it is inelastic Demand is usually more elastic at higher prices and less elastic with lower prices Elasticity and total revenue Price x’s quantity demanded at that price

The Demand for Pizza 8 14 20 26 32 Millions of pizzas per week $15 12 9 6 3 Price per pizza D

Determinants of Demand Elasticity Availability of substitutes The greater the availability of substitutes for a good, the greater the good’s elasticity of demand Share of consumer’s budget spent on the good Increase in prices reduced the demand because people are not both willing and able to purchase @ higher prices A matter of time The longer the adjustment period, the greater the consumer’s ability to substitute Some elasticity estimates The elasticity of demand is greater in the long run because consumers have more time to adjust

Demand Becomes More Elastic Over Time 50 75 95 100 Millions of gallons per day $1.25 1.00 Price per gallon D w D m D y

Selected Elasticities of Demand Product Short Run Long Run Electricity (residential) 0.1 1.9 Air travel 2.4 Medical care and hospitalization 0.3 0.9 Gasoline 0.4 1.5 Movies 3.7 Natural gas (residential) 1.4 2.1

Other Determinants of Demand Consumer Income The prices of related goods The number and composition of consumers Consumer expectations Consumer tastes

Changes in Consumer Income If income ↑, consumers willing and able to buy more which ↑ demand Demand curve shifts to the right Two categories of goods: Normal goods – demand increases as money income increases Inferior goods – demand decreases as money income increases Examples: used clothing, bus rides, etc.

Changes in the Prices of Related Goods Substitutes Decrease in price of one item will reduce the demand for a substitute Example: Tacos and Pizza Complements Certain goods used together Example: airline tickets and car rentals A decrease in the price of one shifts the demand of the other rightward

Changes in Prices of Related Goods (cont) Changes in size or composition of the population will increase demand and shift the curve to the right Changes in consumer expectations can shift the demand curve to the left or the right Changes in consumer tastes Tastes are your likes and dislikes as a consumer

Movement along the Curve Movement vs. Shift A change in price, causes a movement along the demand curve, changes the quantity demanded A change in one of the determinants of demand other than price causes a shift of a demand curve

Extensions of Demand Analysis Role of time Your willingness to pay more for time-saving goods depends on the opportunity cost of your time!