Demand Lecture II by decree

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```									DEMAND LECTURE II

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LETS LOOK AT THE COMMODITY
WHEAT

Price   Surplus
P1                     Supply

Pe                                Demand

Qe            Quantity / unit of time

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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.
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LETS LOOK AT THE COMMODITY
GASOLINE

Price
Supply

Pe                         Demand
P2
Shortage

Qe         Quantity / unit of time
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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.

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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.

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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.

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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.
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DETERMINANTS OF DEMAND

f. Changes in the population.
g. Weather.
i. Availability of substitutes.
j. Proportion of the consumer’s
budget that a particular good
represents.
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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.

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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.

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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:

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Normal Goods or Services

An Increase in disposable income, shifts
Demand curve right.

 Id Demand

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Price

D1

D0

Quantity17
Normal Goods or Services

A Decrease in disposable income shifts
Demand curve left

 Id Demand

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Price

D0

D1

Quantity19
Inferior Good or Service

An Increase in disposable income shifts
curve left.

 Id Demand

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Price

D0

D1

Quantity21
Inferior Good or Service

A Decrease in disposable income shifts
curve right.

 Id Demand

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Price

D1

D0

Quantity23
Inferior Good or Service

Examples:

 Macaroni and   cheese dinners,
 potatoes,
 and rice

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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).

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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.

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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

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Substitutes:

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

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Substitutes:

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

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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.

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Substitutes:

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

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Substitutes:

 Psub DCOI

AND

 Psub DCOI

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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.
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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,
 guns and ammo,
 etc.
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Compliments:

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

 Pcomp DCOI

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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

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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 ?

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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
Price         Result:  Demand for bacon

D0

D1
Qd/ut
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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

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.

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Result:
People bought 3 lbs. of peanut butter

 Demand for peanut butter.

Due to Expectations of higher Price.
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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!

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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.

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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
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
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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
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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.
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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!
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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?

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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.
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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
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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
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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.
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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.
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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.

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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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