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7/21/2019 03 Law of Demand
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Lecture 3Lecture 3
The Law of DemandThe Law of Demand
Our objectives:Our objectives:
Explain individual choices amongExplain individual choices amongunlimited wants in a world of limitedunlimited wants in a world of limited
resourcesresources
Develop a theory that helps us betterDevelop a theory that helps us better
understand and predict human actionsunderstand and predict human actions
What do people our customers! want"What do people our customers! want"
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A Very Dicult IssueA Very Dicult Issue
What we measure in demand is aWhat we measure in demand is arefectionrefectionof individual desires#of individual desires#
Daniel $ernoulli% a mathematical geniusDaniel $ernoulli% a mathematical geniuswho lived in $asel% noted% in &'()% thatwho lived in $asel% noted% in &'()% thatpeople see* goodness or pleasurepeople see* goodness or pleasureutility!#utility!#
+hat is% we do not see* cellphones+hat is% we do not see* cellphonesbecause they are cellphones but becausebecause they are cellphones but becausethey are useful and give us pleasure# ,sethey are useful and give us pleasure# ,seand pleasure cannot be measured% onlyand pleasure cannot be measured% only
approximated#approximated#
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A Note on Value, Scarcity,A Note on Value, Scarcity,
and Price as Related toand Price as Related to
DemandDemandWhy do people want what they want"Why do people want what they want"
+he diamond-water paradox#+he diamond-water paradox#
.carcity need not mean highly valued/.carcity need not mean highly valued/thin* of sna*e meat#thin* of sna*e meat#
0ar*ets re1ect what people value in0ar*ets re1ect what people value in
relationship to current availability#relationship to current availability#
Demand is our best understanding ofDemand is our best understanding of
what people value2given currentwhat people value2given current
conditions#conditions#
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The Law of DemandThe Law of Demand
3olding all other relevant factors constant%3olding all other relevant factors constant%the lower higher! the price of a good% thethe lower higher! the price of a good% thegreater lower! will be the 4uantitygreater lower! will be the 4uantity
demanded#demanded#
5i*e all scienti6c propositions% it is a5i*e all scienti6c propositions% it is a ceterisceterisparibusparibus 7other things e4ual8 or 7other7other things e4ual8 or 7other
things constant8! statementthings constant8! statement
9ote9otethetheterminologyterminology
- rice means opportunity cost- rice means opportunity cost
- ;ood means anything people value- ;ood means anything people value
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!hy focus on the Law of!hy focus on the Law of
Demand"Demand"
This is the most #owerful #ro#osition in economics$This is the most #owerful #ro#osition in economics$
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The Demand %unctionThe Demand %unction
Some De&nitionsSome De&nitions+he relationship between 4uantity consumed and the+he relationship between 4uantity consumed and the
factors determining that: D = f % factors determining that: D = f % ..% % >>%
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The Role of TastesThe Role of Tastes
+hey are very hard to measure% so we+hey are very hard to measure% so wegenerally ignore them% but we *nowgenerally ignore them% but we *now
they exist#they exist#
5oo* to mar*eting and psychology for5oo* to mar*eting and psychology forguidance here% not economists?guidance here% not economists?
@or economists% tastes are often the@or economists% tastes are often theunexplained portion of consumptionunexplained portion of consumption
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'(#ectations'(#ectations
Also diBcult to measure 2 but importantAlso diBcult to measure 2 but important
When measurable% include in the analysis#When measurable% include in the analysis#$ut experience shows2measures are very$ut experience shows2measures are verypoor predictors of actions#poor predictors of actions#
5i*e tastes% these can be used to5i*e tastes% these can be used to7explain8 anything7explain8 anything DonCt fall into this trapDonCt fall into this trap
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This or that"This or that"
.ubstitutes:.ubstitutes:
Essentially% goods used in place of each other2Essentially% goods used in place of each other2
same geographic mar*et/ similar performancesame geographic mar*et/ similar performance
characteristics# What is a substitute in onecharacteristics# What is a substitute in onemar*et may not be seen by consumers as suchmar*et may not be seen by consumers as such
in another mar*et2orange juice and orangein another mar*et2orange juice and orange
soda#soda#
Dierent brands of gasoline/ robots in enaultDierent brands of gasoline/ robots in enaultfactory in @rance v# wor*ers in enault factory infactory in @rance v# wor*ers in enault factory in
ussia former 5ada! paid FGHH a month/ movieussia former 5ada! paid FGHH a month/ movie
theater v# movie rentals/ corn or sugar intheater v# movie rentals/ corn or sugar in
ethanol#ethanol#
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Related )oodsRelated )oods
>omplements:>omplements:
Essentially% goods used togetherEssentially% goods used together
>omputer hardware and software/>omputer hardware and software/
tennis balls and rac*ets/ airplanetennis balls and rac*ets/ airplane
travel and hotel rooms/ ;oogletravel and hotel rooms/ ;oogle
maps and discount coupons/maps and discount coupons/growing corn for ethanol and Deeregrowing corn for ethanol and Deere
tractorstractors
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*han+es in the Price of Related*han+es in the Price of Related
)oods)oods
Goods X and Y areGoods X and Y are substitutessubstitutesif:if:
A change in price of I changes demand for J insame direction
- x up implies Dy up Dy shifts to the right!
- x down implies Dy down Dy shifts to the left!
Eect of change in y on Dx is also in samedirection
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ore on the Prices of Relatedore on the Prices of Related
)oods)oods
Goods V and W areGoods V and W are complementscomplementsif:if:
A change inA change in price of Vprice of Vchangeschanges demanddemandfor Wfor Win opposite direction:in opposite direction:
- Pv up implies D don !D shifts to left"- Pv up implies D don !D shifts to left"
- Pv don implies D !D shifts to right"- Pv don implies D !D shifts to right"
#ffect of a change in P on Dv is also in#ffect of a change in P on Dv is also inoppositeoppositedirectiondirection
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*han+es in Income*han+es in Income
Normal Goods:Normal Goods:
>hange in income changes demand in same direction
- 3igher income causes increase in demand
- 5ower income causes decrease in demand 8.uperior8 good is a variant: change in demand due
to income change is 4uite large
Inferior goods:
>hange in income changes demand in oppositedirection
- 3igher income causes decrease in demand
- 5ower income causes increase in demand
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Terminolo+yTerminolo+y-sed to a.oid confusion-sed to a.oid confusion
>hanges in>hanges in 4uantity demanded:4uantity demanded:
>aused by changes in>aused by changes in own priceownpriceof goodof good
meansmeans movement along a given demandcurve
$hanges in demand:
>aused by changes in other factors:
- rices of other goods
-
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*han+e in Price*han+e in Price
A change in the price of a goodA change in the price of a good
means a movement along ameans a movement along a
demand curve#demand curve#
KuantityLtimeKa Kb
Demand
rice
a
b
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*han+e in Demand*han+e in Demand
A change in a factor that determines demand%A change in a factor that determines demand%
besides the price of the good itself% causes thebesides the price of the good itself% causes the
Demand curve to shift#Demand curve to shift#
Example:
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Deri.in+ a Real DemandDeri.in+ a Real Demand
*ur.e*ur.e
De&ne your mar2etDe&ne your mar2et
oulder, *olorado, o.er time4oulder, *olorado, o.er time4
consum#tion of water 1y #eo#leconsum#tion of water 1y #eo#le
ser.ed 1y city water4 #rice #erser.ed 1y city water4 #rice #er5,666 +allons4 1illions +allons0yr$5,666 +allons4 1illions +allons0yr$
consumed 1y demanders$consumed 1y demanders$
7ear7ear PricePrice /uantity/uantity
589:589: ;6$
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!hat else would you want to 2now"!hat else would you want to 2now"
+he Demand curve plots the relationship+he Demand curve plots the relationship
between price and 4uantity demanded Mbetween price and 4uantity demanded M
nothing else M everything else is held constantnothing else M everything else is held constant
$ut in the real world% other things are not$ut in the real world% other things are not
constant% so what else would you want toconstant% so what else would you want to
*now if you wanted to understand that mar*et*now if you wanted to understand that mar*et
better"better"
9ame li*ely relevant factors:9ame li*ely relevant factors:
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@ard Test@ard Test
!hich )oods Are *om#lements,!hich )oods Are *om#lements,
!hich Are Su1stitutes"!hich Are Su1stitutes"
Wine and beer#Wine and beer#
G#G# Domestic shirts and importedDomestic shirts and importedshirts#shirts#
(#(# Oil from hina#Oil from hina#
N#N# aper and pencils#aper and pencils#
## late glass and bric*Lconcretelate glass and bric*Lconcrete
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Demand analysisDemand analysis
3ow would demand for hair3ow would demand for hair
replacement be li*ely to changereplacement be li*ely to change
if the following occurs"if the following occurs" A fall in the price of hairpieces#A fall in the price of hairpieces#
G#G# A rise in income#A rise in income#
(#(# A rise in the divorce rate#A rise in the divorce rate#
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*le.er sales #itch*le.er sales #itch
A $ritish cellphone companyA $ritish cellphone company
promised new subscribers inpromised new subscribers in
9ovember and December that all9ovember and December that allcalls on >hristmas Day%calls on >hristmas Day%
December G% would be free#December G% would be free#
What would you expect happenedWhat would you expect happenedto the volume of calls that day"to the volume of calls that day"
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/uestion on chan+in+/uestion on chan+in+
demanddemand
+rying to predict future demand% ;E+rying to predict future demand% ;E
research showed that the averageresearch showed that the average
siPe of the American family wassiPe of the American family wasdeclining and so was the averagedeclining and so was the average
s4uare footage of houses#s4uare footage of houses#
3ow would you thin* this impacted3ow would you thin* this impactedthe demand for the design of% say%the demand for the design of% say%
refrigerators"refrigerators"
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ey Point from Peterey Point from Peter
Druc2erDruc2er
0ost important 4uestion sellers must as*:0ost important 4uestion sellers must as*:
BB!hat is .alue to the customer"C!hat is .alue to the customer"C
.ellers often thin* they *now% but do not#.ellers often thin* they *now% but do not#+he customers do not buy a product/+he customers do not buy a product/
they buythey buy .alue$.alue$
Demanders are buying a product to satisfyDemanders are buying a product to satisfy
a want# Do nota want# Do not guessguesswhat customerswhat customerswant2always carefully evaluate whatwant2always carefully evaluate what
theytheywant#want#
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