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Demand Lecture II

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					DEMAND LECTURE II




                    1
LETS LOOK AT THE COMMODITY
WHEAT

Price   Surplus
P1                     Supply


Pe                                Demand




                  Qe            Quantity / unit of time

                                                          2
A SURPLUS

A. Pe and Qe represent the market
    clearing price and quantity.
B. Assume the government sets a price at
   P1:
      1. There is a surplus of goods.
      2. Price must fall for the market to
         clear.
                                             3
LETS LOOK AT THE COMMODITY
GASOLINE

Price
                    Supply


Pe                         Demand
P2
                Shortage


           Qe         Quantity / unit of time
                                                4
A SHORTAGE

C. Assume the government sets a price at
   P2:
     1. There is a shortage of goods.
     2. Price must rise for the market to
        clear.



                                            5
SURPLUS AND SCARCITY?

D. We could have a surplus and still have
 a scarce commodity, RIGHT ?

     1. Yes. This is due to there not
        being enough goods to meet
        demand at a price of zero.


                                            6
7
DETERMINANTS OF DEMAND

As a commodity's own price changes, we
 move along the existing demand
 curve. (Law of Demand)

 A. Other factors affect the demand
    curves position, shape, and slope.


                                         8
DETERMINANTS OF DEMAND

These other determinants, in addition to
 the commodity's own price are:
    a. Consumer disposable income.
    b. Price of substitutes.
    c. Price of complements.
    d. Consumer preferences.
    e. Expectations about the future.
                                           9
DETERMINANTS OF DEMAND

  f. Changes in the population.
  g. Weather.
  h. Length of adjustment period.
  i. Availability of substitutes.
  j. Proportion of the consumer’s
     budget that a particular good
     represents.
                                     10
Consumer’s Disposable Income

1. If we increase consumer's disposable
  income ceteris paribus, what happens?

    · He/she is able to purchase more at
      all price levels.



                                           11
2. The demand curve shifts to the
right.
Price



                         D1

                    D0

                              Quantity 12
3. If we decrease the consumer's
  disposable income ceteris paribus,
  what happens ?

· The consumer cannot purchase the
  same amount of the commodity as
  before, over the entire range of prices.


                                             13
4. The demand curve is said to
shift to the left.
Price



                         D0

                    D1

                              Quantity 14
5. Associated with this income effect, we
  can create another sub-classification
  for commodities:




                                            15
Normal Goods or Services

An Increase in disposable income, shifts
 Demand curve right.

 Id Demand




                                           16
Price



             D1

        D0

                  Quantity17
Normal Goods or Services

A Decrease in disposable income shifts
    Demand curve left

 Id Demand




                                         18
Price



             D0

        D1

                  Quantity19
Inferior Good or Service

An Increase in disposable income shifts
    curve left.

           Id Demand




                                          20
Price



             D0

        D1

                  Quantity21
Inferior Good or Service

A Decrease in disposable income shifts
 curve right.

 Id Demand




                                         22
Price



             D1

        D0

                  Quantity23
Inferior Good or Service

Examples:

 Macaroni and   cheese dinners,
 potatoes,
 and rice
 ROAD KILL !!



                                   24
Change in the price of
substitutes, ceteris paribus:
An increase in the price of a substitute
 will result in an increase in the
 demand for the commodity of interest
 (COI)

         (demand shifts right).


                                           25
For example, lets look at beef while
considering pork as a substitute:

Let the quantity of pork available become
 restricted. What happens?

· There is an increase in the price of pork.




                                               26
  Increase in price of pork due to a
  decrease in Supply of pork:

Price                   S1    S0     Pork Market



  P1
  P0
                                      D

                   Q1        Q0
                                  Qd of pork/ut 27
   There is an increase in the demand for
   beef (COI) because of the increase in the
   price of pork (SUBSTITUTE).
Price                     S0      Beef Market
        P1

        P0
                                        D1
                                   D0

                     Q0
                               Qd of beef/ut    28
     BEEF                  PORK
                             S1
            S0                    S0

P1
                 D1
P0                    P1
                      P0           D0
                 D0




                                   29
Substitutes:

Therefore, an increase in the price of a
 substitute will shift the entire demand
 curve of the commodity of interest to
 the right.




                                           30
Substitutes:

A decrease in the price of a substitute will
 shift the entire demand curve of the
 commodity of interest to the left.




                                           31
Substitutes:

Immediate effect of a supply restriction
  for the substitute is a price increase.

This will affect the demand curve for the
 COI by increasing demand (shifts to the
 right) for the COI.


                                            32
Substitutes:

Immediate effect of a increase in supply is
  a price reduction.




                                          33
Substitutes:


        Psub DCOI

               AND

         Psub DCOI

                          34
Reflect Back:

We have talked about what has
 happened in agriculture when wage
 rates have increased. Capital and
 labor are substitutes for each other.

We have discussed that as the wage rate
 has increased, the demand for capital
 has increased.
                                          35
Change in the price of a
complement, ceteris paribus:
Complements are goods that go together,
  such as:
 left and right shoes,
 gas and cars,
 milk and cereal,
 bread and butter,
 guns and ammo,
 etc.
                                        36
Compliments:

If the price of a complement increases,
   then the demand for the COI decreases.


         Pcomp DCOI


                                            37
   Compliments:

Price             Let the price of milk increase.
                  Since cereal is a complement of milk,
                  its demand will decrease.




                    D0
                  D1

                                   Qd/ut            38
Compliments:

If the price of a complement decreases,
   the demand for the COI increases.


        Pcomp DCOI



                                          39
   Compliments:

Price             Let the price of milk decrease.
                  Since cereal is a complement of milk,
                  its demand will increase.




                    D1
                  D0

                                  Qd/ut             40
Consumer preferences and taste

As preferences change the demand curve
 will also change.

For example: What would be the result of
  the following statements, if true, on the
  demand curve for each commodity ?


                                          41
   Animal fat leads to a higher risk
   of heart attacks.
Price          Result:  Demand for red meat




                            D0

                         D1
                                   Qd/ut
                                               42
  Nitrites in bacon have been
  linked to cancer.
Price         Result:  Demand for bacon




                           D0

                        D1
                                  Qd/ut
                                           43
  Increasing fiber in the diet reduces
  the chance of getting colon cancer.
                    Result: Demand for high fiber
Price               cereals and popcorn.




                               D1
                          D0

                  Quantity / unit of time       44
   Trichinae can be eliminated in
   pork by a new irradiation process
Price
                      Result: ???????




                       D0

                Quantity / unit of time   45
   National Inquirer says that people who own
   and care for rose bushes live 20 years longer
   than the average person.

Price
                             Result: Demand for
                             rose bushes




                                   D1
                              D0

                      Quantity / unit of time       46
Expectations about the future

The peanut butter scare:

a news release said that the peanut crop
  would be short that year and peanut
  butter prices were expected to double.




                                           47
Expectations about the future

Result:
 People bought 3 lbs. of peanut butter
  that month instead of 1lb.


     Demand for peanut butter.

Due to Expectations of higher Price.
                                         48
Expectations: The Self-Fullfilling
Prophecy !
Since consumers expect prices to increase,
  they all run out to buy NOW.

This causes demand to increase, and
 prices are pushed up very quickly!




                                         49
   Graphically Speaking:
Price



$2.00
                                D1
                   D0

            1             3
                        lbs. per month   50
NOTE:

If the commodity we were
  analyzing was not storable,
  then the demand curve may
  NOT shift.


                                51
   Changes in the population of
           consumers
Price             Increase in population
                  will result in increase in
                  Demand for G&S.



                     D1
                D0

                 Quantitiy/unit time 52
   Changes in the population of
           consumers
Price           Decrease in population
                will result in decrease
                in Demand for G&S.




                     D0
                D1

               Quantitiy/unit time        53
    Length of the Adjustment Period
This is tied to, or related to the availability of
  substitutes.
  Price     Short Run: Consumers have little time
            to find suitable substitues.

                      Demand is not very sensitive
                      to price changes, c.p.

                      We say demand is relatively
                      inelastic
           D

                          Quantity per Unit of Time
                                                      54
Length of the Adjustment Period
        Long Run: Consumers have time
Price   to find suitable substitutes.
              Demand becomes more
              sensitive to prices changes
              as time progresses, c.p.
                                  We say demand
                                  is relatively
                                D elastic.


        Quantity Demanded per Unit of Time
                                             55
An Example: Demand for Gasoline

If the price of gas increases from $1.20 per
   gallon to $2.20 per gallon, how will
   consumers respond?

First:
Are we asking how consumers will
  respond over the next day, week,
  month, year, etc.
                                               56
         It makes a difference!
Demand for gas will be different for
 different time periods

The longer the time period considered,
 the flatter the demand curve becomes;
 or the more elastic it becomes.

The more responsive demand becomes to
 changes in price!
                                         57
What Occured in the 1970’s?

What was a simplified sequence of events
 that occurred when gas prices at the
 pump increased so dramatically in the
 1970's?




                                           58
The Sequence of Events:

(1) People griped.
(2) Car pools formed, and bus usage
    increased.
(3) Big cars were replaced with small
    ones.
(4) Some people moved closer to work.
(5) New technology that decreased fuel
    consumption was developed.
                                         59
        What was the result of this
        sequence of events on Demand?
   Price
                       In Short Run, the very large increase
                       in gas price resulted in a very small
                       decrease in consumption of gasoline.
$2.20
                       Consumption of gas will not be very
                       responsive to the increase in price.
$1.20
                       We say demand is relatively inelastic
                   D

           Q1 Q0             Quantity demanded                 60
        As time progressed:
                    In Long Run, consumers have time to
                    find substitutes, and the very large
   Price
                    increase in gas price will eventually
                    result in a significant decrease in
                    consumption of gasoline.
$2.20                     This of course assumes that
                          consumers perceive the increased
                          price of gas to be persistant, not
                          just a temporary price increase.
$1.20
                                   D


              Q1     Q0       Quantity demanded 61
The Availability of Substitutes
     Price       If a commodity has FEW substitutes,
                 demand for the commodity will tend
                 to be more inelastic or less responsive
P1               to price changes.

                 Demand curve will tend to have a
                 very steep slope.
P0

                 D

         Q1 Q0                  Quantity/unit time
                                                       62
The Availability of Substitutes
             If a commodity has MANY substitutes,
     Price   demand for the commodity will tend
             to be more elastic or more responsive
             to price changes.
P1                       Demand will tend to have
                         a very flat slope.


P0
                                     D


             Q1            Q0    Qd/unit time
                                               63
        Proportion of the Consumers Budget
           a Good or Service Represents
Price                     Salt
                 If the price of SALT doubles, how much
                 will this price increase affect the consumption
                 of salt?
  $1.00
                            Why?

   $.50
                      D


              Q1 Q0
                                   Qd/u.t.
                                                           64
Proportion of the Consumers Budget
   a Good or Service Represents
The less of a consumers budget a
 commodity represents, the more
     inelastic the demand curve will tend
 to be.

The price of salt is such a small
 percentage of our budgets, that
 consumption of salt will not be affected
 very much by a price increase.           65
        Proportion of the Consumers Budget
           a Good or Service Represents
Price                  Automobile
                 If the average price of an AUTO doubles,
                 how much will this price increase affect the
                 consumption of Automobiles?
 $40,000                              Why?


 $20,000
                                             D


                 Q1              Q0      Qd/u.t.
                                                         66
Proportion of the Consumers Budget
   a Good or Service Represents
The more of a consumers budget a
 commodity represents, the more
     elastic the demand curve will tend to
 be.

The price of an automobile is such a large
 percentage of our budgets, that
 consumption of automobiles will be
 affected very much by a price increase. 67
Automobile Prices:

Business Week reported on Feb. 7, 1994
 that the 1993 average price of a car was
                 $18,100

This was a 69% increase from 1983. What
 was the average price of a car in 1983?
                 $10,710

                                            68
        Real Price of a Car?

Based on median household income:

In 1983, it required 22 weeks of wages to
  purchase a new car.

In 1993, it required 26 weeks of wages to
  purchase a new car.

                                            69
        Real Price of a Car?

What did the real price of a car do
 between 1983 and 1993 based on
 median household income?

               It Went Up!




                                      70

				
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