Key Topics demand law of demand change in quantity demanded change in demand determinants of demand

Transcription

1 54 Chapter 5 DEMAND Key Topics demand law of demand change in quantity demanded change in demand determinants of demand Goals know the definition of demand understand that demand slopes downward to the right understand when we move along demand understand when demand shifts In Chapter 4 you discovered that an economic system must answer three basic questions: what to produce, how to produce, and for whom. In a market economy, which goods are actually produced depends in part upon the willingness and ability of the consumer to buy (helps to answer what). The resulting scarce goods are allocated to those who are willing and able to buy them (answers for whom). To examine how markets answer the three basic economic questions, we need to find some way to represent the willingness and ability of the consumer to buy the goods. The concept called demand summarizes this willingness and ability of the consumer. The ability and willingness of producers to transform the resources into goods the society wants is summarized in the concept of supply (helps to answer what and answers how). Supply is the subject of the next chapter. In the current chapter, only decisions of the buyer will be examined. Buyers generate demand for goods and services by choosing the goods and services they will consume. Therefore this chapter will focus on demand.

2 Chapter 5. Demand 55 Demand Demand is a familiar concept that is much misunderstood. Many people believe that demand is what you wish for or want. If that were an accurate description of demand, then we would no doubt be riding in Ferraris while also enjoying all the other goods we might ever want. This certainly does not fit our description of scarcity and the real world. Then there are people convinced that demand is what we actually get. If there are six pairs of socks under the Christmas tree, that must be demand, or so they believe. They see demand as a certain amount. In fact, demand is neither what we want nor what we actually get. Since demand is a word in frequent use outside of economics, the word has taken on many different meanings. No wonder when demand is applied to economic situations, it is often misunderstood. Demand is a list or schedule of all alternative (different) quantities of a particular good that a buyer would be willing and able to buy at alternative prices. Several observations should be made about the definition of demand. One critical observation is that because the focus of demand is on the price and the quantity, demand is studied at a point in time when all other considerations are frozen; frozen, that is, in the sense of not having enough time to change. If other considerations besides price change, we cannot tell whether the change in the quantity was due to price or to other considerations. The idea of demand is to see how the buyer reacts to a change in price. So those other considerations are frozen and will be discussed later. For now, the only thing changing that can affect the quantity is price. Another observation is that demand reflects both willingness and ability. A consumer may have enough money but may not be willing to buy the good. Or a consumer may want the good but may not have enough money. So not only must the consumer want the good; the consumer must also have the financial ability to pay the price. The price is the opportunity cost, for convenience measured in money terms. The final observation is to consider who is the demander. When you think of demand, think buyer. Demand represents buyer choice, not seller choice. In fact it makes no difference whether there are many, few, or any sellers of that good. If the consumer is willing and able to purchase the good, then there is a demand. Demand focuses solely on the decisions of the buyer, and in this chapter, only the demand of an individual buyer is considered. How can your demand for a good, such as bottles of hair oil per month, be determined? One simple way is to ask you. Demand is a what if situation.

3 56 Introductory Economics What if the going price of hair oil were $2 a bottle how many bottles would you be willing and able to buy? Now what if the price of hair oil increased to $4, how many bottles would you now be willing and able to buy? And so on through some possible prices of hair oil. What we find is the quantity demanded, the amount you are willing and able to buy at a specific price. When we have found the quantity demanded at each price, we have found your demand. You alone know your demand for hair oil until you provide the demand schedule recorded by Table 5-1. You noted the price of hair oil and then chose the quantity that you would buy at each different price of hair oil. Thus demand is obtained by the buyer making choices. The buyer determines the quantity to purchase, but not the price. You will see how price is determined in Chapter 6. There is no requirement that any of the prices in the demand schedule actually occur. We are developing a statement describing your behavior if any particular price did occur. According to Table 5-1, if the price of hair oil were announced to be $8, you would purchase 1 bottle, and if the price were lower, you would buy even more. How do we know all this? You said you were willing and able to buy. You have revealed your demand. Notice that at $4 a bottle, you said you would purchase 5 bottles and spend $20 ($4 times 5 bottles). Chapter 8, Price Elasticity, will discuss the relation between the price and the amount you spend. And if the price were $8 each, you are able and willing to spend $8 for 1 bottle. So if the price were actually $8, you would purchase 1 bottle of hair oil, as you said. If you were asked to draw a circle around your demand in Table 5-1, where would the circle be? Around $8? $2? Around $4 and the quantity of 5? Recall that Table 5-1 is your demand schedule. Therefore the Table 5-1 Demand Schedule for Hair Oil Price Quantity Demanded ($ Per Bottle) (Bottles) $ This table is the demand schedule for hair oil. It shows the amount of hair oil that a buyer would be willing and able to buy at each price.

4 Chapter 5. Demand 57 entire table should be circled to capture the alternative prices and quantities represented by demand. What happens if the price of hair oil is $5 a bottle? There is no $5 in Table 5-1. We could add more information to the table by asking you, the buyer, for more information. But to obtain the quantity demanded at all prices would require a lengthy table. Another way to summarize demand is with a graph. A graph can readily contain all the information in the table and more. In Figure 5-1 the quantity demanded (bottles) is measured across the bottom of the graph, and the price ($ per bottle) is measured going up the side of the graph. The demand curve is a plot of the demand schedule. To plot the information given in Table 5-1, we would do the following. Start with the $10 and zero bottles. Measure up the side of the graph the price axis until you get to $10. This is the point representing $10 and zero bottles, shown as point A in Figure 5-1. For the next point, $8 and 1 bottle, measure up the side of the graph to $8 and then over to the right until you are just above the 1. This point represents the 1 bottle demanded at the price of $8 per bottle and is labeled B. Continue this process to obtain the points plotted in Figure 5-1. When the points are connected, the downward-sloping line is demand and is labeled D. When an economist says the word demand, he or she means the whole curve, not just a point on the curve. The demand curve permits us to read between the Price A 8 B D Bottles Figure 5-1 The Demand Curve for Hair Oil This figure shows the demand curve for hair oil based on the information in Table 5-1. The demand curve shows the amount of the good a buyer is willing and able to buy at each price. Here at the price of $5 each, the quantity demanded is 4 bottles.

5 58 Introductory Economics prices on the schedule. You can read the demand curve in Figure 5-1 to find that the quantity demanded at the price of $5 each is 4 bottles. The Law of Demand Look again at the demand curve plotted in Figure 5-1. The curve is composed of all the alternative prices of the good and the particular quantity that would be purchased at each price. A certain relationship is established between the price and the quantity demanded. This relationship is known as the law of demand. The law of demand shows an inverse relationship between the price of a good and the quantity demanded of that good. When price goes in one direction, the quantity demanded goes in the opposite direction. Figures 5-2 and 5-3 illustrate this law clearly. As the price decreases from $6 to $4, the quantity demanded increases from 3 to 5 (Figure 5-2). Part of the law of demand states that as price falls, more is purchased. This is indicated by the quantity demanded increasing. The other part of the law of demand states that as price rises, less is purchased. This is indicated by the quantity demanded decreasing. As the price increases from $4 to $6, the quantity demanded decreases from 5 to 3 (Figure 5-3). Observe in Figures 5-2 and 5-3 that the downward-sloping demand curve, from left to right, is a perfect reflection of the law of demand. Price D Bottles Figure 5-2 An Increase in the Quantity Demanded Here we see that if the price decreases, the quantity demanded increases. In this case, we are moving along the demand curve, and demand does not change, but the quantity demanded does.

6 Chapter 5. Demand 59 Price D Bottles Figure 5-3 A Decrease in the Quantity Demanded Here we see that if the price rises, the quantity demanded falls. Again realize that we are moving along the demand curve, so demand does not change, only the quantity demanded. A movement downward along the demand curve represents a fall in price and a corresponding increase in the quantity demanded. A movement upward along the demand curve represents an increase in price and a corresponding decrease in the quantity demanded. There is clear evidence of the law of demand at work all around us. Postage rates increase and fewer Christmas cards are mailed. The quantity demanded has fallen as the price has risen. Retail stores advertise sales. Sales serve to increase the quantity demanded by lowering the price. Buyer response to higher fuel and energy prices will lead to smaller and more fuel-efficient cars, and, in homes, cooler temperatures and sweaters. There is a lower quantity demanded of energy at the higher price. Buyers do respond to changing prices. We are sensitive to sacrifice and changing opportunity cost. What is the reason for the law of demand and the downward-sloping demand curve? Why would we expect a consumer to buy more of a good if its price fell? Part of the explanation lies in the substitution effect of a change in price. As the price of hair oil goes down, hair oil becomes an attractive substitute for other goods. Thus the consumer buys more hair oil to replace those goods. For example, as the price of hair oil goes down, the consumer will buy hair oil to use as lubricant in the lawn mower. If price goes down far enough, the consumer will even buy it to burn as fuel. So one reason why the consumer buys more of a good as the price falls is that the good becomes an

7 60 Introductory Economics attractive substitute for other goods. The consumer buys more of the good and, consequently, less of other goods. Another part of the explanation as to why the demand curve slopes downward is the income effect of a change in price. As the price of a good goes down, the consumer is able to buy more of the good than before the price fell. Therefore the consumer appears to have more income. Note that the amount of money that the consumer actually has remains unchanged. Yet the purchasing power of the money increases as the price falls. For $100, the consumer can buy two $100 suits on sale at one-half off. Thus as the price falls, the consumer can afford to buy more. Income seems to rise and the quantity purchased rises. We now have a second reason to explain why the demand curve slopes downward. And if price rises, these substitution and income effects due to a change in price work in reverse to explain why the consumer would buy less of the good. Other goods would become attractive substitutes for hair oil, and the purchasing power of money would fall; therefore, the quantity demanded of hair oil would fall as the price goes up. People respond to a change in price. That is what the law of demand tells us. The law of demand also specifies the inverse relation of the response. But do not try to interpret more from the law of demand than there is. For example, the law does not tell us how much the price must change before we would respond. It just states that there can be a price change significant enough that we will respond. What if you are planning to get married? And what if the price of a marriage license increases? You might reply that you are going to obtain a license and get married anyway. The law of demand simply predicts that there is a price that either you may not be willing to pay or you may not be able to pay. There is some higher price at which you would rather not have the good, considering what else you would have to give up to pay that price. Or the price could go so high that it was greater than the amount of money that you have and could get; hence price is greater than your ability to pay. As a result, there must eventually be a fall in marriage licenses purchased as the price rises. The law of demand describes how we behave; it does not tell us how to behave. All it does is predict the way we sooner or later respond to changing prices. As the price of Ferraris falls to a nickel each, the law of demand predicts that you would tend to buy more Ferraris than you did at the higher price. Now isn t this an accurate prediction?

8 Chapter 5. Demand 61 Change in Demand One thing and one thing only changes the quantity demanded of a good a change in price of that good. And that is the precise focus of the law of demand the inverse relationship between price and the amount bought. We are all aware of the impact of price on our buying decisions. But we are also aware that there are other factors besides price that determine whether or not we buy a good and in what quantity. Our willingness and ability to purchase may be affected by changing conditions that we will now call the determinants of demand. What are these determinants of demand? If you experience a change in taste or preference for a good, a change in income, an expectation of a change in the price of a good, or a change in the price of a related good, then demand itself may change. This is because your willingness and/or ability to buy the good is affected. Now, our discussion will no longer be concerned with just one point in time but rather over some period of time. This is a length of time just long enough for the determinants of demand to change and then again be frozen. As the determinants of demand change, so will the amount that you are willing and able to buy at each price. Observe closely that this change in the amount of the good bought is not caused by a change in the price of the good. You should clearly understand demand before considering the impact of a change in a determinant of demand. Demand is not just a quantity of 8, or just the price of $6 and the quantity demanded of 3. Demand is the whole schedule or entire curve. When price changes, there is no change in the demand schedule. Table 5-1 still shows your demand, the entire list that records your demand information for hair oil. When price changes, the only effect is that we move on the price column from one price to another and then look up the new quantity demanded. And the law of demand has already predicted that the quantity demanded would move in the opposite direction from price. Look again at Figure 5-1, which shows your demand curve for hair oil. That entire curve, with all the possible prices combined with their quantities demanded, is your demand. When the price changes, the demand curve does not change. In Figure 5-1, we move down the demand curve as price falls and the quantity demanded therefore increases. We move up the demand curve as price rises, and the quantity demanded therefore decreases. The demand curve still goes through the same points and stays in the same place. Yet it is possible for the demand curve to move. But if a change in the price of the good cannot change demand, then what can? When a determinant of demand changes, your entire demand changes. Then Figure 5-1 would no longer

9 62 Introductory Economics show your demand, and we must start the what if questions and find your demand all over again. Only now your demand will be different. Recall that the determinants of demand include a change in taste for a good, a change in income, an expectation of a change in the price of a good, and a change in the price of a related good. Each of these will be discussed in turn. Watch a few reruns of old Elvis Presley movies and see what happens to your demand for hair oil. Suppose that you want hair oil more than before. This reflects an increase in taste or preference. Figure 5-4 shows your old (D 1 ) and new (D 2 ) demand for the good. At the price of $4 a bottle, you would now purchase 8, whereas before you would have purchased 5. You can see that at each and every price you will purchase more hair oil than before. Note that there was not an increase in the quantity demanded. That can only be brought about by a fall in price. The old quantity demanded associated with each price no longer exists, only the new. If someone were to ask you how much hair oil you would buy at $4, you would not reply either 5 or 8 bottles. There is only one quantity that you would now buy at that price, 8 bottles as shown by the new demand curve. Recognize that the price of hair oil did not change. So there is no change at all in the quantity demanded. But of course there is a change, a change in demand. More would be bought than before at each and every price. The demand curve will shift or move to the right. Price D 2 D Bottles Figure 5-4 An Increase in Demand This figure shows the demand for hair oil increasing. Here the whole demand curve shifts to the right from D 1 to D 2. More will be bought at each and every price. Now at $4 each, 8 bottles would be bought rather than 5.

10 Chapter 5. Demand 63 An increase in demand also means that you would be willing and able to pay a higher price than before, if necessary, for each and every quantity. Refer to Figure 5-5. You want the good more than before, and if necessary, you would pay $4 rather than $2 for each of 8 bottles. An increased taste or preference for the product shows that you are more willing to purchase the good than before, hence the increase in demand. If there is a reduction in taste, demand for the product decreases. Figure 5-6 shows a fall in demand. The demand curve shifts to the left. A decrease in demand shows that the buyer is willing and able to buy less than before at each and every price. When electronic calculators first came on the market, there was a decrease in demand for the mechanical machines. People wanted to have the modern electronic calculators, so there was a change in taste away from the mechanical calculators to the electronic calculators and thus an increase in demand for electronic calculators. The buyer s ability to buy is affected by a change in income. An increase in income usually indicates an increase in demand (Figure 5-5), a decrease in income, a decrease in demand (Figure 5-6). This is true of all the so-called normal goods. Almost all goods are normal. So as your income increases, we can expect that your demand for vacations or dinners at a restaurant will increase. For a normal good, demand increases as income increases. The exception is with products referred to as inferior goods. Inferior goods are consumed out of financial necessity, not because of preference. As your income increases, you tend to purchase less of the inferior good, and more of the good you prefer, the normal good. And as your income falls, you purchase more of the inferior good than before, even though its price remains unchanged. Since so many goods are normal, it is difficult to find a clear example of an inferior good. What is inferior to one person may be normal to another. One example we might use for an inferior good is brown bread. It was once true that the poor ate brown bread because it was inexpensive. As income rose, there would be a switch to white bread, and consumption of brown bread would fall. Thus brown bread was an inferior good. Consequently, as income fell, demand for the inferior good would increase and demand for the normal good would decrease. On the other hand, with the current emphasis on health, brown bread may now be a normal good. Review the relationship between income and demand in Table 5-2. Other determinants can also change demand. An expectation of a price increase, if acted upon, can cause demand to increase. If you hear a rumor that the price of hair oil is going up in the near future, you might rush out and buy

11 64 Introductory Economics Price D 2 D Bottles Figure 5-5 An Increase in Demand In this figure we see that another way to think about an increase in demand is that the buyer would pay a higher price at each quantity. Here $4 rather than $2 would be paid for each of 8 bottles if necessary. Price D 1 2 D Bottles Figure 5-6 A Decrease in Demand This figure shows a decrease in demand. The demand curve is shifting left. Less will be bought at each and every price; a lower price would be paid for the same quantity.

12 Chapter 5. Demand 65 Table 5-2 What Happens to Demand When Income Changes Income Demand for the Normal Good Demand for the Inferior Good rises rises falls falls falls rises This table shows the relationship between a change in income and the change in demand that results. If income rises and the good is normal, then demand rises. If the good is inferior, an increase in income causes demand to fall. more hair oil now before it does become more expensive. Take note that the price has not changed, only that you expect it to. The result is an increase in demand since more is bought than before at each and every price of the good. If the expectation, however, is for a fall in price, then you may reduce your buying while waiting for the price to fall. The result is a decrease in demand. A change in the price of some related good may in turn affect the demand for the good in question. Two goods can be related either as complements or substitutes. Goods that are not related are independent. For goods that are complements, if you purchase more (less) of one, you purchase more (less) of the other. There are many common examples of complements that will come to mind, such as beer and pretzels, peanut butter and jam, bread and butter, cameras and film, cars and gasoline, and tennis rackets and tennis balls. With substitute goods, on the other hand, if you buy more (less) of one, you buy less (more) of the other. Examples of substitutes are sugar and saccharin, butter and margarine, coffee and tea, and attendance at any other school and Harvard. Note that whether goods are substitutes or complements is an individual matter. While tea may substitute for coffee in one household, hot chocolate may substitute in another. Suppose that there are two goods, the first good and a related good. What happens if the price of the first good falls? The law of demand predicts an increase in the quantity demanded of the first good. More would be bought at the lower price than at the higher price. But what about the related good? If the two goods are complements, the demand (not the quantity demanded) for the related good will increase. As more is bought of the first good as its price falls, then more is bought of its complement. More of the complement is purchased at the same price. As the price of turkey falls, more turkey and more of its complement, cranberries, are bought. The quantity of turkey demanded increases, as does the demand for cranberries. But if two goods are substitutes, less will be bought of the related good as the price of the first good falls. As

13 66 Introductory Economics Table 5-3 What Happens to Demand for a Related Good When the Price of the First Good Changes First Good Demand for the Related Good Price Quantity Demanded Complement Substitute rises falls falls rises falls rises rises falls This table shows the relationship between the price of a good and the quantity demanded of that good as well as the demand for a complement or substitute. So if the price of a good rises, the quantity demanded of the good falls, the demand for a complement falls, and the demand for a substitute rises. the price of turkey falls, more turkey and less of its substitute, chicken, is bought. Demand for chicken falls. And what happens if the price of the first good increases? As the price of peanut butter goes up, less of the complement good, jam, will be bought. Demand for the complement falls. And as the price of peanut butter goes up, more tuna will be substituted. Demand for the substitute increases. So with a knowledge of demand and the relation between goods, it is possible to predict how a change in price of one good can affect the amount of another you might buy. The demand curve for one good may be shifted by the price change of another good. Thus we are able to classify goods based on how the demand curve shifts when the price of the related good changes. If demand for a good increases as the price of another good goes up, the two goods are substitutes. If the demand for a good decreases as the price of another good goes up, then the goods are complements. Review this relation between goods in Table 5-3. Demand and Quantity Demanded The economist carefully distinguishes between demand, which is the entire curve, and the quantity demanded, a point on the demand curve. When the economist uses the phrase change in demand, the entire demand curve has shifted. Contrast this to the phrase change in the quantity demanded. What is the difference in meaning? A change in the quantity demanded means a movement along a demand curve in response to a price change. Accordingly, a change in price of a good is the only occurrence that can cause a change in the quantity demanded for that good. This is the focus of the law of demand, the response of the buyer to a change in price. A change in demand means

14 Chapter 5. Demand 67 that something else besides the price of the good has changed and affected the willingness and ability of the buyer. This change in a determinant of demand shifts the entire demand curve. You should be able to see the difference between these two concepts in Figure 5-7. In Figure 5-7A, as the price of pizza goes up, you buy less pizza, a change in the quantity demanded. The demand for pizza remains unchanged. The quantity demanded decreased just as your demand curve indicated. You had already revealed that you would buy less pizza at a higher price. However, Price D Price A Pizza D 1 D 2 B Spaghetti Figure 5-7 A Change in Price of a Related Good In graph A the price of pizza rises and the quantity demanded falls. In graph B, the demand for spaghetti increases due to the rise in the price of pizza. More spaghetti is bought at the same price of spaghetti. The entire demand curve moves.

15 68 Introductory Economics there is a change in demand for spaghetti. Demand for spaghetti increased as the price of its substitute, pizza, went up. So at each and every price of spaghetti, you buy more spaghetti than before the price of pizza increased. This is shown in Figure 5-7B as the demand for spaghetti increases from D 1 to D 2. Now for a moment, consider only your new, higher demand for spaghetti. What if the price of spaghetti fell? There would be an increase in the quantity demanded of spaghetti as you move down the existing D 2 demand curve. And now you should be able to predict a fall in demand for pizza. The demand for pizza would shift to the left, indicating that less would be bought than before at each and every price. After all, you are eating more spaghetti and less pizza. You will see the impact of both a change in price and a change in a determinant again in the next chapter. Summary This chapter introduced the concept of demand. Demand has been summarized as the willingness and ability of the buyer to buy goods at each possible price. The law of demand highlights the inverse relationship between price and quantity demanded. The demand curve slopes downward to the right, reflecting the law of demand, explained by both the substitution and income effect of a change in price. Movements along the demand curve are called changes in the quantity demanded; shifts of the entire demand curve are called a change in demand. A change in the price of the good causes a change in the quantity demanded. A determinant of demand must change before demand changes. The determinants of demand include a change in taste, change in income, an expectation of a change in the price of a good, and a change in the price of a related good. Demand is half the story of price determination. In the next chapter, we will introduce the other equally important participant in price determination, supply. Key Concepts demand quantity demanded law of demand substitution effect income effect determinants of demand normal good inferior good complements substitutes change in quantity demanded change in demand

16 Chapter 5. Demand 69 Discussion Questions 1. Buffalo Sam s Snowshovels commissioned a marketing consultant to find the demand for its shovels. The report came with the statement that the demand was for 80,000 shovels. The bill also came. If you were Buffalo Sam, should you pay the bill? Why or why not? 2. Provide an example of an inverse relation in addition to the law of demand. 3. Suppose that you are on your way to the ice cream parlor. You have only enough money for a single scoop. When you arrive, there is a special for economics students, two scoops for the price of one. When you walk out with two scoops, you are showing that the law of demand works. Explain why the law of demand works. 4. The Too-Sweet Cereal Company is considering a new advertising campaign. What impact would Too-Sweet hope the advertising to have on the demand for its product? 5. The price of personal computers has dropped. As a result, what has happened to the demand for computers? 6. When income rises, what would you expect to happen to the demand for cultured pearls as opposed to the demand for imitation pearls? 7. Give an economic explanation for the sequence of events that start when the price of movie theater tickets rises. What impact would there be on the demand for popcorn, video cassette recorders, and video cassette tapes? 8. Which of the following illustrates a change in demand? A change in the quantity demanded? a. You develop a craving for shrimp and buy more. b. The price of shrimp falls and you buy more. c. The price of shrimp falls and you buy more cocktail sauce. d. The price of shrimp falls and you buy less lobster. 9. When the price of swim suits rises, what happens to the demand for swim suits? What happens to the demand for swim towels? 10. What is the difference between the income effect and a change in income? 11. Uncle Effron says that the law of demand is false. He says house prices rise and so does the number bought. Is Uncle Effron right about the law of demand? Explain. Self-Review Fill in the blanks demand The schedule of different prices and the amount that the buyer is willing and able to buy at each price is known as DEMAND. When price changes the amount the buyer will

17 70 Introductory Economics quantity demanded inverse law of demand down up price demand related goods, taste income, price normal right decrease left substitutes complements rises substitute falls complement quantity demanded demand buy, the UAXNTITY DEMANDED changes. There is an INVERSE relationship between price and quantity demanded. The relation is know as the LAW OF DEMAND. This means that as the price goes up, the quantity demanded goes DOWN. And as the price goes down, the quantity demanded goes UXXP. The quantity demanded can be changed only by a change in PRICE. A change in a determinant of demand will change DEMAND itself. The determinants of demand include the price of RELATED GOODS, TASTE, INCOME, and the expectation of a change in PRICE. An increase in income will increase demand for a NORMAL good. When demand increases, the demand curve shifts to the RIGXXHT. An expectation of lower prices would cause demand to DECREASE. A decrease in demand means that the demand curve shifts to the LXEXFT. Goods that are related are either SUBSTITUTES or COMPLEMENTS. When the price of one good rises, the demand for its substitute RISES. An increase in the price of butter increases the demand for margarine, its SUBSTITUTE. When the price of one good rises, the demand for its complement FALLS. An increase in the price of shoes decreases demand for shoelaces, a COMPLEMENT. An increase in the price of shoes results in a decrease in the UANTITY DEMANDED for shoes. Also there is a change in DEMAND for shoelaces. Multiple choice 1. The substitution effect: a. means that the quantity demanded increases as the price falls because the lower price makes the good a more attractive substitute. b. shows how the demand curve changes when a substitute is introduced. c. tells why a substitute is always worse than the real thing. d. is unrelated to demand. 2. When your school increases tuition, the demand for education at its rival: a. rises. b. falls. c. does not change. d. shifts to the left. 3. Which does not cause a change in demand? a. A change in the price of the good. b. A change in the price of a related good.

18 Chapter 5. Demand 71 c. A change in income. d. Expectations of a change in price. 4. Two goods are substitutes if: a. an increase in the price of one causes the demand for the other to rise. b. an increase in the price of one causes the demand for the other to fall. c. they are not complements. d. when the price of one good rises, the price of the other good falls. 5. If the demand for good A goes up as the price of good B falls, you can conclude that goods A and B are: a. substitutes. b. normal goods. c. useful goods. d. complements. Answers: 1.a, 2.a, 3.a, 4.a, 5.d.