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Chapter 2: Demand & Supply
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Chapter 2: Demand & Supply

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  1. Chapter 2:Demand & Supply

  2. Agenda (Game Plan) • Markets & Circular Flow Diagram • What is demand? • The law of demand • The demand curve • Determinants of demand • Change in demand vs. change in quantity demanded • The law of diminishing marginal utility • Elasticity of Demand

  3. What is a Market? • Any network that brings buyers and sellers together so they can exchange goods and services • Doesn’t have to be a physical place, but can be done over the internet, phone or fax • Exists wherever supply and demand determine the price and quantity of goods and services sold • Some markets are Global (Oil) others are local (Hot dogs)

  4. The Circular Flow Diagram • Demonstrates how households & businesses interact • Households are buyers (concept of demand) • Businesses are sellers (concept of supply)

  5. Circular Flow Between Businesses and Households Consumer Goods & Services Money (consumer spending) Business Households Money (household income) Economic Resources (land, labour, Capital & entrepreneurial skills)

  6. Demand: The Consumer Side • Is the quantities of a good or service that buyers are willing and able to purchase at various prices • Demand schedule shows the various prices and quantity demanded at each price • Economists consistently will gather data and put it into a schedule • Then to make it visually easier to understand, put the schedule into graph form

  7. The Law of Demand • Law of Demand: An increase in price will cause a decrease in quantity demanded (and vice versa) • A decrease in price will cause an increase in quantity demanded

  8. The Demand Curve P$ D Price 0 Q Quantity

  9. The Law of Demand • There is an indirect relationship between price (P) and quantity demanded (Qd) • P Qd • P Qd

  10. Change In Demand (D) vs. Change in Quantity Demanded (Qd) • A change in quantity demanded (QD) occurs when there is a change in price (Ceteris Paribus) • This is represented by a move along the demand curve. • A change in demand (D) occurs when there is a change in a demand determinant • This is represented by a shift of the demand curve

  11. Effect of an Increase in Demand P$ D1 D Price Level 0 Q Quantity

  12. Effect of a Decrease in Demand P$ D D0 Price Level 0 Q Quantity

  13. Determinants of Demand • Number of buyers More buyers = more demand & fewer buyers = less demand • Income effect For normal products increased income = increased demand, For inferior products (e.g. canned meat) increased income = decreased demand • Prices of Substitute Products A price increase (decrease) in one product causes an increase (decrease) in the demand for its substitute Eg: Butter/Margarine

  14. Determinants of Demand • Prices of Complementary Products A price increase (decrease) in one product causes a decrease (increase) in the demand for its substitute Eg: Cars and gas, DVD players & DVD’s • Consumer PreferencesA change in consumers tastes and preferences also affects demand. Eg. Nutrition, fashion, safety. • Consumer Expectations Expectation of future price changes will alter current demand (e.g. gas price increases the immediate future will cause consumer to fill their tanks earlier)

  15. Law of Diminishing Marginal Utility • Law of Diminishing Marginal Utility satisfaction diminishes with increased consumption. Therefore must decrease price to increase consumption • Each additional unit of a good or service that is consumed brings less satisfaction or “utils” than the previous unit consumed • This helps explain why the demand curve is downward sloping • Measurement in utils of human satisfaction when consuming products • Consume up to and including the point where your satisfaction level is equal between two products MU / P1 = MU / P2

  16. Elasticity of Demand • Shows the responsiveness of the quantity demanded to a change in price • P x Qd = TR (total revenue) • Elastic Demand • P < Qd • Inelastic Demand • P > Qd • Unitary Demand • P = Qd

  17. Factors Affecting Price Elasticity of Demand Portion of Consumer Incomes Access to Substitutes Necessities vs. Luxuries Time

  18. Portion of Consumer Incomes Products taking up larger portions of income are more responsive (elastic) to price changes (stereo, rent) Smaller purchases tend to be more inelastic (bread, milk, salt) Access to Substitutes The demand for products with close substitutes will be more elastic (e.g. margarine and butter) FACTORS AFFECTING ELASTICITY OF DEMAND

  19. FACTORS AFFECTING ELASTICITY OF DEMAND • Necessities vs. Luxuries • Consumers usually purchase similar quantities of basic necessities (such as milk, eggs, bread etc) regardless of price. Therefore, demand is inelastic. • Luxury items (such as vacations, jewelry, boats) tend to be elastic. • Time • Demand tends to be more elastic over time. • Eg. Petroleum, natural gas, electricity

  20. Applications • Homework P. 68-69 #1-7 • Determinant of Demand Exercise (blue sheet) • Article & Questions: Electronic Gadgets