1. Unit 1: Demand, Supply, and Consumer Choice

2. The Circular Flow Model
The Product Market-
The “place” where goods and services produced by businesses are sold to households.
The Resource (Factor) Market-
The “place” where resources (land, labor, capital, and entrepreneurship) are sold to businesses. 2

3. Resource Market DEMAND SUPPLY Individuals Businesses Government SUPPLY
$$$ Income $$$
(Factor payments)
$$$ Costs $$$
Resources
Resources
(Factors of
Production)
$$$
Taxes
Taxes
Subsidies
Transfer Payments
Public Goods
Public Goods
Individuals
Businesses
Government
$$$
Goods and
Services
Goods and
Services
$$$ Revenue $$$
SUPPLY
$$$ Spending $$$
DEMAND
Product Market 3

4. Circular Flow Model Vocab
Private Sector- Part of the economy that is run by individuals and businesses
Public Sector- Part of the economy that is controlled by the government
Factor Payments- Payment for the factors of production, namely rent, wages, interest, and profit
Transfer Payments- When the government redistributes income (ex: welfare, social security)
Subsidies- Government payments to businesses 4

5. 2012 Exam C 5 5

6. Demand

7. DEMAND DEFINED What is Demand? What is the Law of Demand?
Demand is the different quantities of goods that consumers are willing and able to buy at different prices.
(Ex: You are able to purchase diapers, but if you aren’t willing to buy then there is NO demand)
What is the Law of Demand?
There is an INVERSE relationship between price and quantity demanded

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

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

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

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

13. Can you see the Law of Diminishing Marginal Utility in Disneyland’s pricing strategy?

14. 2010 Question 36 D

15. Graphing Demand

16. Let’s draw a new demand curve for milk…
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 milk…

17. GRAPHING DEMAND Draw this large in your notes Demand Schedule
Price of Milk
Draw this large in your notes $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Q
Quantity of Milk

18. GRAPHING DEMAND Demand Schedule Price of Milk $5 10 $4 20 $3 30 $2 50
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand Q
Quantity of Milk 18

19. Where do you get the Market Demand?
Billy
Jean
Other Individuals
Market
Price
Q Demd $5 1 $4 2 $3 3 $2 5 $1 7
Price
Q Demd $5 $4 1 $3 2 $2 3 $1 5
Price
Q Demd $5 9 $4 17 $3 25 $2 42 $1 68
Price
Q Demd $5 10 $4 20 $3 30 $2 50 $1 80 P P P P $3 $3 $3 $3 D D D D Q Q Q Q 3 2 25 30

20. Demand Review (In your Homework)
What are the two key aspects of the definition of demand?
What is the Law of Demand?
Give an example of the substitution effect
Give an example of the income effect
Give an example of the law of diminishing marginal utility
Explain how the law of diminishing marginal utility causes the law of demand
How do you determine the MARKET demand for a particular good? (from reading)
Name 10 fast food places

21. Shifts in Demand
Ceteris paribus-“all other things held constant.”
When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts.
A shift means that at the same prices, more people are willing and able to purchase that good.
This is a change in demand, not a change in quantity demanded
PRICE DOESN’T SHIFT THE CURVE

22. Change in Demand What if milk makes you smarter? Demand Schedule
Price of Milk
What if milk
makes you smarter? $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand Q
Quantity of Milk

23. Change in Demand What if milk makes you smarter? Demand Schedule
Price of Milk
What if milk
makes you smarter? $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand Q
Quantity of Milk 23

24. Change in Demand Demand Schedule Price of Milk $5 30 $4 40 $3 50 $2 701
Price
Quantity
Demanded $5 30 $4 40 $3 50 $2 70 $1
Demand Q
Quantity of Milk 24

25. Prices didn’t change but people want MORE Milk
Change in Demand
Demand Schedule
Price of Milk
Increase in Demand
Prices didn’t change but people want MORE Milk $5 4 3 2 1
Price
Quantity
Demanded $5 30 $4 40 $3 50 $2 70 $1 D1
Demand Q
Quantity of Milk 25

26. Change in Demand What if milk makes causes baldness? Demand Schedule
Price of Milk
What if milk
makes causes baldness? $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand Q
Quantity of Milk 26

27. Change in Demand What if milk makes causes baldness? Demand Schedule
Price of Milk
What if milk
makes causes baldness? $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
Demand Q
Quantity of Milk 27

28. Change in Demand Demand Schedule Price of Milk $5 $4 5 $3 20 $2 30 $1
Quantity
Demanded $5 $4 5 $3 20 $2 30 $1
80 60
Demand Q
Quantity of Milk 28

29. Prices didn’t change but people want LESS Milk
Change in Demand
Demand Schedule
Price of Milk $5 4 3 2 1
Decrease in Demand
Prices didn’t change but people want LESS Milk
Price
Quantity
Demanded $5 $4 5 $3 20 $2 30 $1
80 60 D2
Demand Q
Quantity of Milk 29

30. The demand stays the same
Change in Demand
Demand Schedule
Price of Milk
What happens to
the demand for milk if
the price of milk
goes up? $5 4 3 2 1
Price
Quantity
Demanded $5 10 $4 20 $3 30 $2 50 $1 80
NOTHING!
The demand stays the same
Demand Q
Quantity of Milk 30

31. Change in Qd vs. Change in Demand
There are two ways to increase quantity from 10 to 20
Price of Milk P
A to B is a change in quantity demand (due to a change in price)
A to C is a change in demand (shift in the curve) A C $3 $2 B D2 D1
Q Milk
Quantity of Milk

32. What Causes a Shift in Demand?
5 Shifters (Determinates) of Demand:
Tastes and Preferences
Number of Consumers
Price of Related Goods
Income
Future Expectations
Changes in PRICE don’t shift the curve. It only causes movement along the curve.

33. Prices of Related Goods
The demand curve for one good can be affected by a change in the price of ANOTHER related good.
Substitutes are goods used in place of one another.
Ex: If price of Pepsi falls, demand for coke will…
If the price of one increases, the demand for the other will increase (or vice versa)
2. Complements are two goods that are bought and used together.
Ex: If price of hot dogs falls, demand for hot dog buns will...
If the price of one increase, the demand for the other will fall. (or vice versa)

34. Substitutes or Complements?

35. Substitutes 35 35

36. Substitutes 36 36

37. Substitutes 37 37

38. Substitutes 38 38

39. Substitutes 39 39

40. Substitutes 40 40

41. Substitutes 41 41

42. Substitutes 42 42

43. Complements 43 43

44. Income
The incomes of consumer change the demand, but how depends on the type of good.
Normal Goods
Ex: Luxury cars, Sea Food, jewelry, homes
As income increases, demand increases
As income falls, demand falls
2. Inferior Goods
Ex: Top Ramen, used cars, used clothes
As income increases, demand falls
As income falls, demand increases
Spam-Inferior
Yachts- Normal
Off Brand Cereal-Inferior
McDonald’s-Inferior
Toilet Paper- Probably no connection to income (The point-some products are very reliant on income and others are not)

45. Inferior Goods 45 45

46. Practice Questions
1. Which of the following will cause the demand for milk to decrease?
Increase in the price of a substitute
A decrease in income assuming that milk is a normal good
A decrease in the price of milk
An increase in the price of milk
A decrease in the price of a complementary good
Answer B

47. Practice Questions
2. Which of the following will cause the quantity demanded of milk to decrease?
Increase in the price of a substitute
A decrease in income assuming that milk is a normal good
A decrease in the price of milk
An increase in the price of milk
A decrease in the price of a complementary good
Answer D

48. Practice
Identify the determinant (shifter) then decide if demand will increase or decrease
Shifter
Increase or Decrease
Left or Right 1 2 3 4 5 6 7 8

49. Hamburgers (a normal good)
Practice
Identify the determinant (shifter) then decide if demand will increase or decrease
Hamburgers (a normal good)
Population boom
Incomes fall due to recession
Price of tacos, a substitute, decreases
Price increases to $5 for hamburgers
New health craze- “No ground beef”
Hamburger restaurants announce that they will significantly increase prices NEXT month
Price of fries, a complement, increases
Restaurants lower price of burgers to $.50
Number of consumers, increase.
Income, decrease.
Price of Related Goods (Substitute), decrease.
Price doesn’t shift curve, no change.
Tastes and preferences, decrease.
Expectations, increase.
Price of Related Goods (Complements), decrease. 49 49