Chapter 2:Chapter 2:Demand & SupplyDemand & Supply

Agenda (Game Plan) Markets & Circular Flow Diagram What is demand? The law of demand The demand curve Determinants of demand Change in demand vs. change in quantity demanded The law of diminishing marginal utility Elasticity of Demand

What is a Market?

Any network that brings buyers and sellers together so they can exchange goods and services

Doesn’t have to be a physical place, but can be done over the internet, phone or fax

Exists wherever supply and demand determine the price and quantity of goods and services sold

Some markets are Global (Oil) others are local (Hot dogs)

The Circular Flow Diagram

Demonstrates how households & businesses interact

Households are buyers (concept of demand) Businesses are sellers (concept of supply)

Circular Flow Between Businesses and Households

Business Households

ConsumerGoods & Services

Money(household income)

Economic Resources(land, labour, Capital & entrepreneurial skills)

Money (consumer spending)

Demand: The Consumer Side Is the quantities of a good or service that

buyers are willing and able to purchase at various prices

Demand schedule shows the various prices and quantity demanded at each price

Economists consistently will gather data and put it into a schedule

Then to make it visually easier to understand, put the schedule into graph form

The Law of Demand

Law of Demand: An increase in price will cause a decrease in quantity demanded

(and vice versa) A decrease in price will cause an increase in

quantity demanded

The Demand Curve P

rice

Quantity

DDP$

Q0

The Law of Demand

There is an indirect relationship between price (P) and quantity demanded (Qd)

P Qd

P Qd

Change In Demand (D) vs. Change in Quantity Demanded (Qd)

A change in quantity demanded (QD) occurs when there is a change in price (Ceteris Paribus)

This is represented by a move along the demand curve.

A change in demand (D) occurs when there is a change in a demand determinant

This is represented by a shift of the demand curve

Effect of an Increase in DemandEffect of an Increase in Demand P

rice

Lev

el

Quantity

DD

Q0

DD11P$

Effect of a Decrease in DemandEffect of a Decrease in Demand P

rice

Lev

el

Quantity

DD

Q0

DD00

P$

Determinants of Demand1. Number of buyers

More buyers = more demand & fewer buyers = less demand

2. Income effect For normal products increased income = increased demand, For inferior products (e.g. canned meat) increased income = decreased demand

3. Prices of Substitute Products A price increase (decrease) in one product causes an increase (decrease) in the demand for its substituteEg: Butter/Margarine

Determinants of Demand

4. Prices of Complementary Products A price increase (decrease) in one product causes a decrease (increase) in the demand for its substituteEg: Cars and gas, DVD players & DVD’s

5. Consumer Preferences A change in consumers tastes and preferences also affects demand. Eg. Nutrition, fashion, safety.

6. Consumer Expectations Expectation of future price changes will alter current demand (e.g. gas price increases the immediate future will cause consumer to fill their tanks earlier)

Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility satisfaction diminishes with increased consumption. Therefore must decrease price to increase consumption

Each additional unit of a good or service that is consumed brings less satisfaction or “utils” than the previous unit consumed

This helps explain why the demand curve is downward sloping

Measurement in utils of human satisfaction when consuming products

Consume up to and including the point where your satisfaction level is equal between two products MU / P1 = MU / P2

Elasticity of Demand Shows the responsiveness of the quantity

demanded to a change in price P x Qd = TR (total revenue) Elastic Demand P < Qd Inelastic Demand P > Qd Unitary Demand P = Qd

Factors Affecting Price Elasticity of Demand

Portion of Consumer Incomes

Access to Substitutes

Necessities vs. Luxuries

Time

FACTORS AFFECTING ELASTICITY OF DEMAND

1. Portion of Consumer Incomes– Products taking up larger portions of income are more

responsive (elastic) to price changes (stereo, rent)– Smaller purchases tend to be more inelastic (bread,

milk, salt)

2. Access to Substitutes– The demand for products with close substitutes will

be more elastic (e.g. margarine and butter)

FACTORS AFFECTING ELASTICITY OF DEMAND

3. Necessities vs. Luxuries– Consumers usually purchase similar quantities of

basic necessities (such as milk, eggs, bread etc) regardless of price. Therefore, demand is inelastic.

– Luxury items (such as vacations, jewelry, boats) tend to be elastic.

4. Time– Demand tends to be more elastic over time.– Eg. Petroleum, natural gas, electricity

Applications

Homework P. 68-69 #1-7 Determinant of Demand Exercise (blue

sheet) Article & Questions: Electronic Gadgets