Understanding Demand

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 E. Napp

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. E. Napp

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

Why do we purchase more when a sale occurs? E. Napp

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. E. Napp

It’s obvious, isn’t it? Consumers love low prices. E. Napp

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. E. Napp

It really depends on the price, doesn’t it? E. Napp

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. E. Napp

Lower prices allow consumers to increase demand. Lower prices increase consumers’ purchasing power. E. Napp

A demand schedule records the quantity demanded at various prices. E. Napp

A demand schedule can easily be converted to a demand curve. E. Napp

Economists love graphs because graphs provide easy understanding of economic concepts. E. Napp

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

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? E. Napp

Gas prices keep rising but we keep buying! E. Napp

Doesn’t the law of demand state that consumers buy less at higher prices? So, why are we still buying gas? E. Napp

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. E. Napp

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

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

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

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

So, why is our demand for apple juice elastic and our demand for gasoline inelastic? E. Napp

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.) E. Napp

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. E. Napp

However, we cannot substitute milk for gasoline. E. Napp

What is this graph telling us about elasticity of demand? E. Napp

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

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. E. Napp

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

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. E. Napp

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. E. Napp

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. E. Napp

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

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 E. Napp

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

Advertising can increase demand at all price levels. E. Napp

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

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. E. Napp

Understanding Demand