Chapter 3Chapter 3

DemandDemand DemandDemand (D) is the amount of a good or service a (D) is the amount of a good or service a

consumer is willing and able to purchase at various consumer is willing and able to purchase at various prices during a given period of time.prices during a given period of time.

W + A = DW + A = D

Quantity DemandedQuantity Demanded (QD) is the amount of a good (QD) is the amount of a good or service a consumer is willing and able to purchase or service a consumer is willing and able to purchase at each price during a given period of time.at each price during a given period of time.

What is the difference What is the difference between D and QD?between D and QD?

D measures W + A at D measures W + A at various prices.various prices.

QD measures W + A at QD measures W + A at one (particular) price.one (particular) price.

The Law of DemandThe Law of Demand When the price of a good When the price of a good

or service increases, the or service increases, the quantity demanded quantity demanded decreases.decreases.

When the price of a good When the price of a good or service decreases, the or service decreases, the quantity demanded quantity demanded increases.increases.

This is an inverse This is an inverse (opposite) relationship.(opposite) relationship.

Demand ScheduleDemand Schedule Illustrates the relationship Illustrates the relationship

between the price of a good or between the price of a good or service and the quantity service and the quantity demanded for the good or demanded for the good or service. service. Shows the law of demand.Shows the law of demand.

Price Per CarPrice Per Car Quantity DemandedQuantity Demanded

$10,000$10,000 10001000

$8,000$8,000 12001200

$6,000$6,000 15001500

$4,000$4,000 30003000

$2,000$2,000 50005000

A demand graph is a graphic illustration of the demand A demand graph is a graphic illustration of the demand schedule. schedule.

A demand curve plots the information from the demand A demand curve plots the information from the demand schedule on to the demand graph.schedule on to the demand graph.

Each plotted point on the graph represents a specific Each plotted point on the graph represents a specific combination of price and quantity demanded.combination of price and quantity demanded.

The demand curve slopes downward, right.The demand curve slopes downward, right.

P

QD1,000

4,000

6,000

10,000

8,000

2,000

1,200 1,500 3,000 5,0000

Price Per CarPrice Per Car Quantity Quantity DemandedDemanded

$10,000$10,000 10001000

$8,000$8,000 12001200

$6,000$6,000 15001500

$4,000$4,000 30003000

$2,000$2,000 50005000

D

Examples of the Law of DemandExamples of the Law of Demand The Income EffectThe Income Effect

1. 1. Purchasing PowerPurchasing Power - The - The amount of money one has amount of money one has available to spend on goods available to spend on goods and services.and services.

2. Any change in a consumers’ 2. Any change in a consumers’ purchasing power which is purchasing power which is caused by a change in pricecaused by a change in price

3. The income effect may not 3. The income effect may not always apply.always apply.

The Substitution EffectThe Substitution Effect Substitute goodsSubstitute goods - Goods - Goods

that can be used in place of that can be used in place of one another. one another.

Consumers tend to Consumers tend to substitute a similar, lower-substitute a similar, lower-priced good for another priced good for another good that is higher-priced.good that is higher-priced.

The substitution effect may The substitution effect may not always apply.not always apply.

Diminishing Marginal UtilityDiminishing Marginal Utility UtilityUtility - Usefulness or satisfaction gained from the - Usefulness or satisfaction gained from the

consumption of a good or service.consumption of a good or service. With each additional unit of consumption of a good With each additional unit of consumption of a good

or service, less satisfaction from each unit of or service, less satisfaction from each unit of consumption will be received.consumption will be received.

Demand will decrease because at some point, Demand will decrease because at some point, consumers cannot use any more of a good or consumers cannot use any more of a good or service. service.

Demand ShiftsDemand Shifts With the passage of time, factors other than price With the passage of time, factors other than price

(non-price factors) can affect demand for a good or (non-price factors) can affect demand for a good or service.service.

The result of non-price factors affecting demand is The result of non-price factors affecting demand is that the entire demand curve shifts either to the right that the entire demand curve shifts either to the right or to the left.or to the left.

This means that quantity demanded changed at This means that quantity demanded changed at every price.every price.

PP

QQ

An An INCREASEINCREASE in in demand shifts the demand shifts the entire demand curve entire demand curve to the to the RIGHT.RIGHT.

A A DECREASEDECREASE in in demand shifts the demand shifts the entire demand curve entire demand curve to the to the LEFTLEFT

There are five non-price factors which determine There are five non-price factors which determine demand for a good or service:demand for a good or service:

1. Consumer Taste and Preference1. Consumer Taste and Preference2. Market Size2. Market Size3. Income3. Income4. Prices of Related Goods4. Prices of Related Goods5. Consumer Expectations5. Consumer Expectations

Consumers’ taste Consumers’ taste and preference for and preference for comfort, quality, comfort, quality, trends, holidays, trends, holidays, seasons, etc. can seasons, etc. can have an effect on have an effect on demanddemand

Market SizeMarket Size Changes in the size of the Changes in the size of the

market can have an effect on market can have an effect on demand. demand.

Three factors can change Three factors can change market size:market size:

1.1. Decisions made by Decisions made by private businessesprivate businesses

2.2. Government policiesGovernment policies

3.3. New technologyNew technology

IncomeIncome Changes in Changes in

consumers’ income consumers’ income can have an effect on can have an effect on demand.demand.

Prices of Related GoodsPrices of Related Goods

The demand for a good or The demand for a good or service can be affected by service can be affected by the prices of related goodsthe prices of related goods

Two types of related goods:Two types of related goods:1.1. Substitute goodsSubstitute goods are are

goods that can be used to goods that can be used to replace a similar goodreplace a similar good

2.2. Complementary goodsComplementary goods are goods that are usually are goods that are usually used togetherused together

Consumer ExpectationsConsumer Expectations

Expectations of Expectations of one’s future income one’s future income can have an effect can have an effect on demand.on demand.

Elasticity of DemandElasticity of Demand The degree to which changes in good’s price affect the quantity The degree to which changes in good’s price affect the quantity

demanded by consumers.demanded by consumers. Exist when small change in a good’s price causes a major, Exist when small change in a good’s price causes a major,

opposite change in quantity demandedopposite change in quantity demanded Can change if:Can change if:

The product is not a necessityThe product is not a necessity There are readily available substitutes There are readily available substitutes The product’s cost represents a large portion of The product’s cost represents a large portion of

consumer’s incomeconsumer’s income

Inelastic DemandInelastic Demand Exist when a change in a good’s price has little impact on the Exist when a change in a good’s price has little impact on the

quantity demandedquantity demanded Can change ifCan change if

The product is a necessity The product is a necessity There are few or no readily available substitutes for the There are few or no readily available substitutes for the

productproduct Product cost represents a small portion of consumers Product cost represents a small portion of consumers

incomeincome

Measuring Elasticity Measuring Elasticity Total-revenue testTotal-revenue test – refers to the total income a – refers to the total income a

business receives from selling its products.business receives from selling its products. Monitoring changes in prices before & after – Monitoring changes in prices before & after –

determines elasticity of demand for a product.determines elasticity of demand for a product. Prices can make inelastic or elasticPrices can make inelastic or elastic