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Demand Chapter Four Sections One and Two Macro vs Micro Economics Macroeconomics = the whole picture Microeconomics deals with behavior and decision making by small units such as individuals and firms. Demand Demand is the desire to own something and the ability to pay for it. Law of Demand The Law of Demand says When a good's price •Price is lower, consumers will buy more When a good's price is higher, consumers will buy less The law of demand is the result of two •Demand patterns of behavior- substitution effect and income effect Substitution Effect When consumers react to an increase in price by consuming less of that good and more of another good, economists call this the substitution effect. For example, if the price of movie tickets rises then you'll tend to go to the movies less and substitute another activity for going to the movies. Income Effect Income is the change in consumption resulting from a change in real income. Real income is the income of an individual, organization, or country, after taking into consideration the effects of inflation on purchasing power. When prices overall go up, even if you have the same amount of money you can no longer do the same things. Instead of buying two slices of pizza, if the prices rise, you may buy only one or buy two and forgo something else. Demand Schedule Demand Schedules explain how much will be demanded at certain prices. Just because you want an object, doesn't mean that you can afford it. A demand schedule shows how many people both want an item and can afford it at different prices. Demand Schedule Market Demand Schedule Market Demand Schedules show quantities demanded by all consumers in the market. This allows business owners to predict the total sale of an item if it is sold at different prices These can be created by surveying customers and adding up the number of people who say they'll buy an item at certain prices. Demand Graph • If you plot the price and quantity demanded found on a demand schedule on a graph you will see the demand graph. • The line you see is the demand curve. • Prices will always be on the vertical axis • Quantity demanded will always be on the horizontal axis How are these two different? Reading a Curve Demand graphs assume that price and quantity purchased are the only things that are not constant. This means that we assume that other things like income, prices of similar goods, and quality of the product will not change. As price decreases, demand will always increase. Demand curves are only good at predicting how much people will buy at differing prices. Ceteris Paribus The demand curves in the last few slides assumed that nothing other than quantity and price changed. Economists call this ceteris paribus. Ceteris paribus is Latin for all other things are held constant Now we're going to talk about what happens when we take other factors into account. Accuracy Demand curves are accurate when the only things changing are price and quantity. However, there are other things that can change the quantity demanded. What are some examples you can think of? What Changes Demand? Recall the Definition. Taste (This = Desire) Income (This = Ability to Pay C S Taste • As we grow up, hear information, learn more etc our opinions and feelings change • The way we want, desire, feel or like something is TASTE INCOME • Due to our salary, pay checks, job opportunities we have more or less money to spend. • This change in Income changes our ability to buy COMPLIMENTARY ITEMS • These items go together. • For example if the cost of peanut butter goes way down, we desire more jelly. SUBSTITUTES • These items can be exchanged for the other. • If the cost of peanut butter goes way up, we may buy more pizza for lunch. Pizza can be exchanged for PB and J sandwiches. This is why Dooley wants you to remember Taste Income Complimentary Items Substitutes + Population and Expectations Expectations If a price on a good that you desire is going to be raised or lowered, this affects how you feel about buying that object. If you know the price is going to go up, then you feel that you need to purchase that item right then If you know the price is going to go down, you are more willing to wait until the price is lowered. Population The size and age of the population will make more items in demand in others How do you think that demand was changed by the Baby Boomers? How will demand for items change as the Baby Boomers begin to retire? How would demand for individual stores change if the population of a town increased or decreased? Two more Oddities before we have some Graphing Fun If prices go up…sometimes the demand for inferior goods increases. This is because Inferior Goods can be exchanged for Luxury Items (Substitutes) IE: Kellogs cereal or Brand X cereal One more Oddity before we have some Graphing Fun • When changing Demand remember: • I NCREASE TO THE • R IGHT • D ECREASE TO THE LEFT Elasticity of Demand Chapter 4 Section Three Elasticity of Demand Elasticity of demand- the way that consumers respond to price changes Inelastic- demand for a good that goes unchanged even if prices increase Examples? Elastic- demand for a good changes greatly if there is a price increase Examples? Calculating Elasticity Remember that the law of demand says that whenever there is an increase in price, there will be a decrease in demand Price range helps to determine the elasticity of a good Demand for a good at one price may be elastic but at another price the same good might be inelastic Elasticity If the price of a magazine rose from $ .20 to $ .30. This is a 50% increase but the price still isn't truly high. If the price of a magazine rose from $4 to $6, demand for the price would go down Formula Elasticity is found by Elasticity = Percentage change in quantity demanded Percentage change in price Percentage change= Original Number- New Number x100 Original Number Value of Elasticity If the elasticity of a good is less than 1, then we call this good inelastic. If the elasticity is greater than 1, then demand is elastic. If the elasticity of a good is 1, then we describe this as unitary elastic. This means that the percentage change of quantity demanded is exactly equal to the percentage change in the price of the good. Elasticity... Ifthe price of a pizza goes up from $1 to $1.50, and the quantity of the pizza fell from 4 to 3. The change in price is ____ The change in quantity demanded is ___ Elasticity of Slice of Pizza Use the formula to figure out whether the price of pizza is elastic... Factors Affecting Elasticity Availability of Substitutes Relative Importance Necessities vs Luxuries Availability of Substitutes If there are few substitutes for a good, then even when its price rises greatly, you might still buy it. (Inelastic) Ex: Concert Ticket; Medicine A wide choice of substitutes can make demand elastic. Give some Examples… Relative Importance How much of your budget you already spend on an item will help determine the elasticity of a product The more you spend on a item, the greater a difference in price will affect your budget. If the price goes up, then you will have to decide if you are going to spend more on that product or reduce how much you buy. Examples: Clothes; Shoelaces Needs v. Wants Whether or not an item is considered to be a need or want will effect the elasticity. What items do you think are inelastic because they are needs? What items do you think are elastic because they are wants? Change over Time Consumers do not always react quickly to a change in price because it takes time to find substitutes Demand sometimes can be inelastic in the short run and become more elastic as time goes on. Ex: Gasoline Elasticity and Revenue Total revenue is defined as the amount of money the company receives by selling its goods The law of demand states that as prices rise there will be less demand, this means that by raising prices firms could stand to lose money rather than gain more Remember that elastic demand comes from one or more factors Availability of substitute goods Limited budget that doesn't allow for price changes Perception of a good as a luxury good Total Revenue and Inelastic Demand Ifa good is inelastic, then demand won't change much because of prices. This means that prices going up will not cause the firm to lose as much demand for the product. The higher price will make up for the decrease in demand and the firm will make more money Elasticity and Pricing Policies Firms use elasticity of a good to figure out whether or not it would be helpful or harmful to their revenue to raise the price of a good. State whether the goods are elastic or inelastic Salt Inelastic Elastic or Inelastic? Matches Inelastic Elastic or Inelastic? Restaurant Meals Elastic Elastic or Inelastic? Toothpicks Inelastic Elastic or Inelastic? Chevrolet Automobiles Elastic Find the Elasticity 1. An increase in the price of orange juice from $2.39/half gallon to $2.45/half gallon accompanied by a 2.5% decrease in sales. 2. An increase in the price of gasoline from $0.99/gallon to $1.39/gallon is accompanied by a decrease in sales of 0.5%. 3. A decrease in the price of a taco from $2.35 to $1.99 causes an increase in sales from 1,225 tacos to 1,550 tacos. 4. The price of a haircut at an exclusive shop increases by 12%, causing the number of haircuts to decrease from 40 per day to 27 per day. PRICE QUANTITY Initial New Initial New % change in % change in Elasticity of demand price Demand 25 30 100 40 40 70 120 90 200 220 80 64 50 75 150 135 In each case tell me whether you would describe it as elastic, inelastic or unitary elastic Which of the following goods are likely to have elastic demand and which are likely to have inelastic demand? Home heating oil Pepsi Chocolate Water Heart Medication Oriental Rugs 1. Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes. Today, the price has gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. Find the elasticity of demand. 2. Suppose the price of a particular good increases from $95-$105. As a consequence, you decrease your purchases of the good from 21 units to 19 units. What is the elasticity of demand? 3. Suppose the price of a good increases from $95-$105. As a result, your purchases of the good decrease from 41 to 39 units. What is the price elasticity of demand?
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