Section 2 – Demand and Supply By:J.A.SACCO

Demand What is meant by demand and supply? What are the basic elements that determine the price of anything? How are prices determined by the seller? What influence do you have on the determination of price? Why can you buy many things at a lower price in a supermarket than in a local general store? You all have had experience as a buyer---- Have you had experience as a seller? How are the goals different? Why?

DEMAND Quantity demanded The amount of a good, service, or resource that people or a group are willing and able to purchase at various prices during a specified point in time all other things being constant Don’t dive right in by drawing a demand-supply graph on the board. Tease the ideas out of the students with one of these exercises: Quick exercise to generate demand curve: Pick a good (say a slice of pizza) and propose that a person would be willing to buy one slice at a price of $4. Now pick a student and ask the student if you reduced the price to $3 a slice, how much pizza would he or she be willing to buy. Next ask the same student how much he or she would buy at $2 per slice and then ask about $1 a slice. It is helpful for you to pick the initial price and quantity so the student has a starting point for the subsequent choices. You are then guaranteed an easy-to-graph relationship between price and quantity. Do this same experiment for one or two more students. Use the data provided by your volunteer students by collecting the demand schedule on the board. Graph the resulting demand curve, explicitly labeling the axes. Make the point that as the price of a slice falls the students are willing to buy more slices, and that as the price of a slice rises the students are willing to buy fewer slices. Then inform the students that they have just “discovered” the law of demand! Finally, use the demand curve by moving between several points on the curve. Emphasize that these “movements along the demand curve” are a change in the quantity demanded and are the result of changes in the price of a slice of pizza.

DEMAND Law of Demand Other things remaining the same, If the price of the good/service rises, the quantity demanded of that good decreases. If the price of the good/service falls, the quantity demanded of that good increases. Experiment to generate demand curve (needs about 30 minutes): Of the hundreds of classroom experiments that are available today, very few are worth the time they take to conduct. The classic demand-revealing experiment is one of the most productive and worthwhile ones. Bring to class 2 bottles of ice-cold, ready-to-drink, Coke or bottled water or sports drink. (If your class is very large, bring 6 bottles). Tell the students that you have these drinks and ask them to indicate if they would like one. Most hands will go up and you are now ready to make two points: (i) The students have just revealed a want but not a demand. (ii) You don’t have enough bottles to satisfy their wants, so you need an allocation mechanism. Ask the students to suggest some allocation mechanisms. You might get suggestions such as: give them to the oldest, the youngest, the tallest, the shortest, the first-to-the-front-of-the-class. For each one, point out the difficulty/inefficiency/inequity. If no one suggests selling them to the highest bidder, tell the class that you are indeed going to do just that. Tell them that this auction is real. The winner will get the drink and will pay. Ask for a show of hands of those who have some cash and can afford to buy a drink. Explain that these indicate an ability to buy but not a definite plan to buy. Begin the auction. Appoint a student to count hands (more than one for a big class) and appoint another student to keep a spreadsheet (see the Parkin Website for a sample that you can download). [continued on next slide note] Why is there an inverse relationship between price and the quantity demanded?

Income/ Purchasing Power Effect Substitution Effect Demand There are THREE economic concepts that explain the Law of Demand and these concepts account for the inverse relationship that changes in the price of goods/services have on the quantity demanded: Income/ Purchasing Power Effect Substitution Effect Diminishing Marginal Utility

Income/Purchasing Power Effect Amount of money a person has to spend on goods/services is called purchasing power. It is not a change in a person’s income but a change in purchasing power (real income) because of a change in the price of the good/service. Pr. Pur.Pwr. QD Pr. Pur.Pwr. QD

Substitution Effect Price A (NORMAL) QD To substitute a lower priced product/service (generic) for a normal product/service that is more expensive. Price A (NORMAL) If there is a substitute than the quantity demanded of that normal good will decrease. QD What happens if there is not a substitute?

Diminishing Marginal Utility What is UTILITY? The usefulness of a good/service or the satisfaction one gets from that good/service. As the price of a good/service decreases, the quantity demanded increases, but for each successive decrease in price, the quantity demanded will increase but at a smaller rate. You will get to a point where the quantity demanded will reach zero- at that point you have no more utility for that good/service. D.M.U.

Diminishing Marginal Utility

Diminishing Marginal Utility

Demand Schedule and Demand Curve Now that we know why there is an inverse relationship between price and quantity demanded, lets look at an economic model of the law of demand.

DEMAND Demand schedule Demand curve This is a numerical representation of the inverse relationship between specific relative prices and quantity demanded. Demand curve This is a graphic representation of the demand schedule. A negatively sloped line showing the inverse relationship between relative price and quantity demanded.

DEMAND

DEMAND Individual Demand and Market Demand Market demand The sum of the demands of all the buyers in a market. The market demand curve is the horizontal sum of the demand curves of all buyers in the market. The greater number of individuals in a market demand curve the more accurate the curve.

DEMAND

A Change in Demand A CHANGE IN PRICE! Review- Change in the Quantity of Demand A CHANGE IN PRICE! Income Effect Diminishing Marginal Utility Substitution Effect *Just a SNAPSHOT- ONLY PRICE MATTERS- Ceteris Paribus

A Change in Demand Change in demand A change in the quantity that people plan to buy when any influence other than the price of the good changes. A change in demand means that there is a new demand schedule and a new demand curve. This shift in the demand curve causes an overall change in the level (quantity) of demand at each and every price.

Change in Demand Figure shows changes in demand. 1. When demand decreases, the demand curve shifts leftward from D0 to D1. 2. When demand increases, the demand curve shifts rightward from D0 to D2.

Change in Demand There are many influences that effect the change in demand. These influences are called NON- PRICE DETERMINANTS of DEMAND.

Non-Price Determinants of Demand Consumer Taste and Preferences When taste/preferences change, the demand for one item increases and the demand for another item (or items) decreases. Seasonal Style Fads Location Age

Non-Price Determinants of Demand Market Size Population- Pop. increases/demand increases. Pop. Decreases/demand decreases. Technology- Must have it! Advertisement Gov’t Decisions- Gov’t involvement in other countries shrinks/expands market– embargo, tariffs Social/Economic Changes

Non-Price Determinants of Demand Change in Income This is an ACTUAL change in your income! Not the Income Effect!! Normal good (Beef steak) A good for which the demand increases if income increases and demand decreases if income decreases. Inferior good (Beef hot dogs)- not a substitute! A good for which the demand decreases if income increases and demand increases if income decreases.

Non-Price Determinants of Demand Change in Consumer Expectations Expected Future Income? Expected Future Price of Good/Service? Expected Good/Service Availability?

Non-Price Determinants of Demand Prices of Related Goods Substitute (not generics) A good that can be consumed in place of another good. For example, Coca Cola and Pepsi Cola. The demand for a good increases, if the price of one of its substitutes rises. The demand for a good decreases, if the price of one of its substitutes falls.

Non-Price Determinants of Demand Complements A good that is consumed with another good. For example, peanut butter and jelly. The demand for a good increases, if the price of one of its complements falls. The demand for a good decreases, if the price of one of its complements rises.

Non-Price Determinants of Demand

Change in Quantity Demand vs. Change in Demand Change in Quantity Demanded Versus Change in Demand Change in the quantity demanded A change in the quantity of a good that people plan to buy that results from a change in the price of the good. (move up and down the demand curve) Change in demand A change in the quantity that people plan to buy when any influence other than the price of the good changes. (Shift of the demand curve)

Change in Quantity Demand vs. Change in Demand When you draw a shift of the demand, be careful to draw the arrows in the horizontal direction. Follow the text by always describing shifts of demand and supply curves as “rightward” or “leftward.” Do not say that the curves shift “up” or “down” or “inward” or “outward.”

Class Questions For the following graph each demand situation. Include the reason for the change in the graph. LABEL EVERYTHING! 1) Received $2000 tax refund--- Demand for a new digital camera. 2) Price of jelly increases by 25 cents--- Demand for peanut butter 3) NY Rangers win the Stanley Cup---- Demand for NY Ranger tee-shirts 4) Price of a NY Jets ticket from $60-$70---- Demand for a NY Jets ticket 5) Population of the U.S. increases---- Demand for inexpensive housing 6) Price of Wise potato chips decreases---- Demand for Lays chips 7) New CD’s the size of a quarter---- Demand of old CD’s

Class Questions 8) Just been fired from your job--- Demand for a new I-Phone 9) Buy one hat get every additional hat at 50% off--- Demand for hats 10) Price of gasoline increases---- Demand for large cars 11) Nike sneakers used by Olympic athletes--- Demand for Nike sneakers 12) Price of Intel computer chip---- Demand for AMD computer chip