PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College

1. “The Economic Way of Thinking”10th Editionby Paul Heyne, Peter Boettke, and David Prychitko “Substitutes Everywhere:The Concept of Demand PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College Chapter 3

2. Chapter Outline • Introduction • On the Notion Of “Needs” • The Concept of Demand • Marginal Values • Decisions at the Margin • Making it Graphic

3. Chapter Outline Chapter Outline • Demand and Quantity Demanded • The Difference It Makes • Law of Demand: A Summary • Misperceptions caused by Inflation • Time is on Our Side • Price Elasticity of Demand • Thinking about Elasticity

4. Chapter Outline Chapter Outline • Elasticity and Total Receipts • The Myth of Vertical Demand • All Scarce Goods Must be Rationed Somehow • Money Cost and Other Cost • Once Over Lightly

5. Introduction • Most goods are scarce. • Sacrifice is necessary. • There are substitutes for everything. • Intelligent choice entails trade-offs. • Market price signals encourage buyer to economize

6. Introduction • What is wrong with the following statements? 1) Fire safety requires that there be two exits from each apartment unit. 2) We need a new car.

7. What is the relationship between “tradeoffs” and “needs”? Consider these four statements……… The average person needs eight glasses of water per day to maintain good health. All citizens should be able to obtain the medical care they need regardless of their ability to pay. A diabetic needs insulin. You need to read your economics textbook. On the Notion of “Needs” All of these statements have necessity in common.

8. On the Notion of “Needs” • Higher prices (sacrifices) lead people to seek substitutes. • The fact that goods and services are scarce entails tradeoffs, i.e., the sacrifice of other goods and services that we value.

9. The Concept of Demand • Demand • Relates amounts people want to obtain to the sacrifices they must make • When a want can only be satisfied at some cost we accept less.

10. The Concept of Demand • “Law of Demand” • A negative relationship exists between the amount of anything that people want to purchase and the price they must pay.

11. The Concept of Demand • Question: Are there any exceptions to the Law of Demand? • “Let’s stock up before the price goes even higher.” • Answer: Alleged exceptions are based on misinterpretation of the evidence. • Expectations of future price increases encourages people to buy more now, so that they can buy less later at the higher price.

12. Marginal Values • Questions • Which is more valuable, water or diamonds? • Which is more valuable, a glass of water or a glass of diamonds? • Answers: • The values that matter are marginal values • Marginal means “additional”, so in economics we make decisions based on expected marginal benefits, versus marginal cost.

13. Decisions at the Margin • Decisions are not made in terms of “all or nothing.” • The “Economic Way of Thinking”…. • Measures the change in one alternative, versus the change in another, compared to the original state of affairs. • Marginal decision making is true for people who economize on any scarce food, including a basic “necessity” such as water.

14. Making It Graphic • Graphs can be used to illustrate relationships. • Demand Curves • Illustrate the relationship between price and quantity demanded

15. Making It Graphic Price per Gallon Gallons per Day $.07 25 .04 40 .02 80 .01 160 .005 320 Demand Schedule is a tabular representation of graphical data:

16. Making It Graphic $.07 .06 .05 .04 PRICE PER GALLON .03 .02 .01 .00 0 40 80 120 160 200 240 280 320 360 400 GALLONS OF WATER PER DAY

17. Making It Graphic • Economic theory assumes: • Households compare price with its “utility.” • Consumption decreases when marginal benefit is less than the price. • Total usefulness is the area under the curve.

18. P P D2 D D1 Q Q Demand and Quantity Demanded • “A change in demand” is not the same thing as a “change in quantity demanded”. • Demand is a relationship between two specific variables. • It is a schedule or a curve. Change in demand:: Change in Quantity demanded:

19. Price Quantity Demanded Demand and Quantity Demanded 50 cents 125,000 40 160,000 30 175,000

20. Demand and Quantity Demanded • A change in quantity demanded is a movement from one point on a curve to another point on the same curve. • A change in demand results from some other factor that makes households buy more at each price. • The demand curve shifts.

21. Demand and Quantity Demanded Price per Gallon Original Gallons/Day New Gallons/Day $.07 25 40 .04 40 60 .02 80 140 .01 160 240 .005 320 400

22. Demand and Quantity Demanded $.07 .06 .05 .04 PRICE PER GALLON .03 .02 .01 .00 0 40 80 120 160 200 240 280 320 360 400 GALLONS OF WATER PER DAY

23. Demand and Quantity Demanded Price Per Gallon Original Gallons/Day New Gallons/Day $.07 25 15 .04 40 25 .02 80 55 .01 160 100 .005 320 200

24. Demand and Quantity Demanded $.07 .06 .05 .04 PRICE PER GALLON .03 .02 .01 .00 0 40 80 120 160 200 240 280 320 360 400 GALLONS OF WATER PER DAY

25. The Difference It Makes • An editorial in The Wall Street Journal incorrectly stated, • “The coffee market is behaving the way the basic textbooks say a market behaves: Prices go up, demand falls, and prices come down.” • Price and quantity demanded move in opposite directions.

26. The Difference It Makes • Demand for a good is a function of: • Biological realities • Social relationships • Psychological factors • Economic variables • Income • Substitutes

27. D1 D2 A fall in the demand The Difference It Makes P Q

28. D Price goes up, quantity demanded goes down, period! P2 P1 Q2 Q1 The Difference It Makes P Q

29. P Demand for bicycles: effect of a lower price Q The Difference It Makes

30. Demand for bicycles: effect of environmental concern The Difference It Makes P Q

31. Other things constant, if the price of a good changes, the quantity demanded changes. A higher price decreases quantity demanded. A lower price increases quantity demanded. A change in price causes movement along a stable demand curve. When something other than price changes, the whole demand curve changes (shifts) either to the right (increase), or to the left (decrease). The Law of DemandA Summary

32. The non-price determinants of demand that encourage consumers to buy more or less are……… Changes in consumer taste and preferences. Changes in incomes. Changes in the price of other goods and services. Changes in expectations. Demand can increase or decrease because of these factors. The Law of DemandA Summary

33. Time Is On Our Side • Changes in the quantity demanded takes time. • These changes will be greater for any price change the longer the time period allowed for adjustment. • It takes time for customers to find and begin to use substitutes. • It also takes time for producers to devise, produce, and publicize substitutes.

34. Price Elasticity of Demand • Price elasticity of demand measures consumer responsiveness to price changes. • Inelastic Demand • If quantity demanded changes very little as a result of a large change in price. • Elastic Demand • If quantity demanded changes substantially as a result of a small change in price.

35. Price Elasticity of Demand

36. Price Elasticity of Demand • Example • Price increases by 20% • Quantity demanded decreases by 50% • Consumers are relatively responsive • Elastic • Example • Price decreases by 20% • Quantity demanded increases by 15% • Consumers are relatively unresponsive • Inelastic

37. Price Elasticity of Demand • Elastic Demand • Price elasticity > 1 • Inelastic Demand • Price elasticity < 1 • Unit Elastic • Price elasticity = 1

38. Thinking About Elasticity • “People aren’t going to buy much more no matter how far we cut the price.” • “This is a competitive business. We would lose half our customers if we raised our prices by as little as 2 percent.” • Question • Would a firm want to lower price if demand were inelastic? • Question • Would a firm want to raise price if demand were elastic? The answer is no to both questions.

39. P D Inelastic Demand Q Thinking About Elasticity

40. P Elastic Demand D Q Thinking About Elasticity

41. Thinking About Elasticity • Question • Can food stores charge any price they want since they sell food? • Question • Would it be wise to impose a tax on table salt? • Question • Would the demand for Morton’s salt be more elastic or inelastic than the demand for salt?

42. Thinking About Elasticity • A product’s elasticity depends upon…. • The proportion of one’s budget spent on an item. The more a product takes of your budget, the more elastic. • The more substitutes a product has, the more elastic. • Necessities are less elastic than luxuries. • All products become more elastic with time.

43. Elasticity and Total Receipts • “The university’s total receipts from tuition would actually increase if tuition rates were cut by 20 percent.” • The 20 percent cut in prices must cause quantity demanded to increase by more than 20 percent. • Elastic demand

44. Elasticity and Total Receipts • “It’s odd but true. Wheat farmers would gross more money if they all got together and burned one-quarter of this year’s crop.” • Elastic Demand • Prices and total receipts move in opposite directions. • Inelastic Demand • Prices and total receipts move in the same direction.

45. P Elastic demand between C and E since OBCG < OAEF. C B E A D Q G F Elasticity and Total Receipts O

46. P Inelastic demand between A and B. B A D Q Elasticity and Total Receipts

47. Demand for wheat The price when 1/4 of crop is burned. The market price when entire crop is sold Elasticity and Total Receipts P Q

48. P1 D P2 The Myth of Vertical Demand P Q

49. The Myth of Vertical Demand • Question • Does a perfectly inelastic demand curve exist? • Will consumers buy the same quantity at all prices? • There is no such thing as a completely inelastic demand curve over the entire possible range of prices. • If the price of insulin falls diabetics would be more likely to purchase a larger quantity, implying that the demand curve for insulin is downward sloping.

50. All Scarce Goods must be Rationed Somehow • Market prices and willingness to pay are our primary criteria for rationing goods and services. • If a good is scarce, sacrifices must be made to obtain it. • When prices of products and services rise, people respond by economizing in their use. • People naturally find ways to economize that entail the least sacrifices.