Understanding Demand

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1 Understanding Demand Students will be able to identify characteristics of the law of demand. Students will be able to define and/ or identify the following terms: Law of Demand Substitution Effect Income Effect

2 ESSENTIAL QUERY EQ: What is demand, and how does it impact economies? Content Standard 3: The student will explain how prices are set in a market economy using supply and demand graphs and will determine how price provides incentives to buyers and sellers. 1. Analyze how price and non-price factors affect the demand and supply of goods and services available in the marketplace. 2. Explain what causes shortages and surpluses including government imposed price floors, price ceilings, and other government regulations and the impact they have on prices and people s decisions to buy or sell.

3 Look at this demand curve. What happens to quantity purchased as prices rise?

4 Why do we purchase more when a sale occurs?

5 The Law of Demand The law of demand states that consumers buy more of a good when its price decreases. Conversely, consumers buy less of a good when its price increases. Consumers love low prices.

6 It s obvious, isn t it? Consumers love low prices.

7 The Substitution Effect One reason that the law of demand exists is the substitution effect. The substitution effect occurs when a consumer reacts to an increase in a good s price by buying less of that good and more of a similar yet cheaper good. When the price of orange juice rises, consumers substitute cheaper apple juice for orange juice.

8 It really depends on the price, doesn t it?

9 The Income Effect The income effect is the change in consumption resulting from a change in income. In other words, when prices rise, your money buys less. Higher prices reduce your purchasing power.

10 Lower prices allow consumers to increase demand. Lower prices increase consumers purchasing power.

11 A demand schedule records the quantity demanded at various prices.

12 A demand schedule can easily be converted to a demand curve.

13 Economists love graphs because graphs provide easy understanding of economic concepts.

14 If a picture is worth a thousand words, a graph is worth even more.

15 Questions for Reflection: State the law of demand. Provide an example of the substitution effect. How does the income effect lead to the law of demand? What is a demand schedule? What is a demand curve? Why do economists love graphs?

16 Gas prices keep rising but we keep buying!

17 Doesn t the law of demand state that consumers buy less at higher prices? So, why are we still buying gas?

18 Elasticity of Demand Elasticity of demand is a measure of how consumers react to a change in price. Inelastic demand is demand that is not very sensitive to a change in price. Elastic demand is demand that is very sensitive to a change in price.

19 Think pants. These pants have inelastic waistbands. The waistbands do not change if people gain weight.

20 Our demand for gasoline is inelastic. It does not change even with a price increase.

21 Think pants again! Sweat pants have elastic waistbands. The pants change depending on the size of the person.

22 Our demand for apple juice is elastic. If the price increases, we will buy less. Our demand changes.

23 So, why is our demand for apple juice elastic and our demand for gasoline inelastic?

24 Factors Affecting Elasticity of Demand The following are factors that can affect the elasticity of demand: Availability of Substitutes Relative Importance Necessities Versus Luxuries Time (It takes time to find substitutes.)

25 It s obvious, isn t it? We can substitute orange juice for apple juice. Therefore, we deal with a price increase by substituting one product for another product.

26 However, we cannot substitute milk for gasoline.

27 What is this graph telling us about elasticity of demand?

28 While the price of a good influences a consumer s decision to purchase, it is not the only factor.

29 Ceteris Paribus Ceteris Paribus is a Latin phrase meaning that all other things are held constant. A demand curve assumes Ceteris Paribus or that only price is changing while all other things are held constant. In other words, a demand curve only looks at price. It does not consider other factors that influence demand.

30 As any parent will tell you, sometimes cereal is only bought for the toy inside.

31 Shifts in the Demand Curve When a demand curve shifts, it moves. Price can never shift a demand curve because price is in the demand curve. To shift a demand curve, it must be some factor other than price.

32 D is the original demand curve D1 is the demand curve after it has shifted. Notice that by shifting to the left, demand has decreased at every price level.

33 Here is a simple rule to remember: If the curve shifts left, left means less. Demand has decreased at every price level. If the curve shifts right, right means more. Demand has increased at every price level.

34 Certainly, an outbreak of Mad Cow s Disease would decrease demand for beef at every price level.

35 Factors that Can Shift a Demand Curve The following are factors that can shift a demand curve: Advertising Population Consumer Taste Consumer Expectations about Future Prices The Price of Complements The Price of Substitutes

36 The Baby Boom generation increased demand for goods at all price levels.

37 Advertising can increase demand at all price levels.

38 Complements are goods purchased together. If the price of the Game Cube rises, people will buy fewer games.

39 If we think the price of a popular good will drop, we will buy less at all price levels today and wait for the future lower price.