Understanding Demand

Demand is the desire to own something and
the ability to pay for it
◦ Both of these conditions must be present

Law of Demand says that when a good’s price
is lower, consumers will buy more of it
◦ When the price is higher, consumers will buy less
◦ A price of a good will strongly influence your
decision to buy

The law of demand is a result of two separate
patterns
◦ Substitution effect and income effect
◦ Describes two ways that consumers changes his or
her spending patterns
◦ Together they explain why an increase in price
decreases the amount purchased
◦ Changes consumers buying habits

Substitution effect
◦ Takes place when a consumer reacts to a rise in
price of one good by consuming less of that good
and more of a substitute good
◦ Also applies to a drop in price

Income effect
◦ The change in consumption that results when a
price increase causes real income to decline
◦ Also works when prices drop

To have demand of a good, you must be able
to buy it at a specific price
◦ If you can’t afford a good, you don’t demand it

Demand schedule
◦ Is a table that lists the quantity of a good that a
person will purchase at various prices in a market
Price of a slice of pizza
Quantity demanded each
day
$1.00
5
$2.00
4
$3.00
3
$4.00
2
$5.00
1
$6.00
0

Market Demand Schedule
◦ When you add up the demand schedules of each
buyer in the market you create a market demand
schedule
Price of a slice of pizza
Quantity demanded per
day
$1.00
300
$2.00
250
$3.00
200
$4.00
150
$5.00
100
$6.00
50

Ceteris paribus is a Latin phrase for “all other
things are held constant
◦ The demand schedule for pizza only took into
account changes in price
◦ Didn’t take into account other factors like news
reports
◦ Demand curve is only accurate if there are no other
changes but price
 Then it is just an increase or decrease in the quantity
demand

When we drop ceteris paribus then the demand curve
shifts
◦ A shift in the curve means that at every price,
consumers buy a different quantity then before
◦ This is what economists call a shift in demand
◦ If an individual’s town is hit by a heat wave, if they
no longer feel like having pizza, then they will
demand fewer slices at every price
◦ Refer to the graphs on page 92

Income
◦ A consumer’s income affects his or her demand for
most goods
◦ Most items we purchase are normal goods, goods
that consumers demand more of when their
incomes increase
◦ An increase in income can cause individuals to
show a greater demand for pizza at every slice
◦ This would produce a curve to the right or an
increase in demand
◦ Inferior goods are goods that you would buy in
smaller quantities, or not at all, if your income were
to rise and you could afford something better

Consumer Expectations
◦ Our expectations about the future can affect our
demand for certain goods
◦ Expecting a higher price in the future, your more
likely going to buy the product today
 Caused immediate demand increase
◦ If your told the product will go on sale next week,
your demand will fall to zero
◦ The current demand for a good is positively related
to its expected future price
 If prices are expected to rise, demand will rise

Population
◦ Changes in the size of population will affect
demand for most products
 Demand for houses, food, and other goods and
services
◦ Refer to page 94 WWII example
◦ In the next few decades the market will face rising
demand for the goods and services desired by
senior citizens

Demographics
◦ Are the statistical characteristics of population,
such as age, race, gender, occupation, and income
level
◦ Businesses use the data to identify who potential
customers are, where they live, and how likely they
are to purchase a specific product
◦ Also packing, pricing, and advertising
◦ Hispanics and Asians create shifts in demand for
goods and services (growing population).

Customer Tastes and Advertising
◦ Economists can not always explain why some fads
begin, advertising and publicity often play a role
◦ Advertising is a factor that shifts the demand curve
because it plays an important role in many trends
◦ New media and technology led to new trends in
advertising
◦ Online advertising
◦ Companies advertise because they believe it will
increase demand

The demand curve for one good can also shift
in response to change in the demand for
another good
◦ Complements are two goods that are bought and
used together
 Example skis and ski boots
◦ Substitutes are goods that are used in place of one
another
 Example is snowboards

Economists describe the way that consumers
respond to price change as elasticity of
demand
◦ Measures how drastically buyers will cut back or
increase their demand for a good when prices
rise or falls
◦ If you buy the same amount or just a little less of a
good after a large price increase, your demand is
inelastic, or relatively unresponsive to price
changes
◦ If you buy much less of a good after a small price
increase, your demand is elastic, or very responsive
to a price change
Percentage change= original # - new #
Original #
x 100
Elasticity= % change in quantity demand
% change in price


The law of demand implies that the number
will always be negative, but for simplicity
sake, economists drop the negative sign
Refer to example on page 98

The elasticity of demand for a good varies at
every price
◦ The demand for a good at one price may be elastic,
and inelastic at a different price

The terms inelastic and elastic have precise
mathematical definitions
◦ If the elasticity of demand for a good is less than 1,
the demand is inelastic
◦ If the elasticity is greater than 1, the demand is
elastic
◦ If elasticity is equal to 1, then it is unitary elastic
◦ Refer to page 99

Availability of Substitutes
◦ If there are only a few substitutes for a good, then
even when its price rises, you still buy it
◦ A concert, and life-saving medicines are examples
of inelastic demand
◦ A wide choice of substitutes will make demand
elastic
◦ Apples are an example of an elastic demand

Relative Importance
◦ Second factor in determining a good’s elasticity of
demand is how much of your budget you spend on
the good
◦ The higher the jump in price, the more you will
have to adjust your purchases
◦ If you spend half your income on clothes, a
moderate increase will cause a reduction in quantity
or demand become elastic
◦ if shoe laces doubled in price, you probably still
purchase the good and the demand is inelastic

Necessities Versus Luxuries
◦ Whether a person considers a good to be a
necessity or luxury has a great impact on a person’s
elasticity of demand
◦ A necessity a good people will always buy, even
when prices increase
◦ If milk prices rise from $3.49 to $5.49, most
parents will still by it to keep their children healthy
◦ If steak prices increases then people may reduce
the amount of steak bought or skip it altogether

Changes Over Time
◦ When prices change, consumers often need time to
change the spending habits and find substitutes
◦ Because consumers can’t respond quickly, their
demand is inelastic for the short term
◦ Refer to page 102


Elasticity of demand determines how a
change in prices will affect a firm’s revenue,
or income
Computing a Firm’s Total Revenue
◦ Total revenue is defined as the amount of money
the company receives by selling its goods
◦ Determine by two factors: the price of the goods
and the quantity sold
150 slices of pizza x $4.00 per slice = $600

Total Revenue and Elastic Demand
◦ When a good has an elastic demand, raising the
price of each unit by 20% will decrease the quantity
sold by a larger percentage, maybe 50%
◦ This will reduce the firm’s revenue
◦ The same will happen if the price decreases and
quantities increase causing revenue to rise

Total Revenue and Inelastic Demand
◦ When demand is inelastic, prices and total revenue
move in the same direction
◦ Refer to page 103