Law of Demand

What Is the Law of Demand?

Demand: a relation showing the quantities of a good that consumers are willing and able to buy at various prices per period, other things constant.

The Law of Demand states that consumers buy more of a good when its price decreases and less when its price increases.

The law of demand is the result of two separate

behavior patterns that overlap, the substitution effect and the income effect.

Other-Things-Constant Ceteris paribus or “other things

constant” Assumed the “other things” to remain

constant are the prices of other goods.

The Substitution Effect & Income Effect

The Substitution Effect• The substitution effect occurs when consumers

react to an increase in a good’s price by consuming less of that good and more of other goods.

• Example: if the price of pizza drops and the price of other goods remains the constant, pizza becomes relatively cheaper. People tend to substitute pizza for other goods and vice versa.

The change in the relative price – the price of one good relative to the prices of other goods – causes the substitution effect.

The Substitution & Income Effect

The Income Effect• The income effect happens when a person

changes his or her consumption of goods and services as a result of a change in real income.

• Example: income effect of a price change Income remains consistent but price of pizza

drops – how many more pizzas can you buy?

Marginal Utility Marginal Utility: the change in total utility

resulting in a one-unit change in consumption of a good.

OR… the satisfaction you derive from an additional unit of a product is called your marginal utility.

• Example: Pizza

Law of Diminishing Marginal Utility• The more of a good a person consumes per period, the

smaller the increase in total utility from consuming one more unit, other things constant.

How Funny is Charlie? Create the following

table in your notes Each time we watch

the video, rate 0-10 your enjoyment of the video.

0 is the lowest score 10 is the highest

score

# of times “Charlie” is

viewed

Total Utility

Law of Diminishing Marginal Utility

The law of diminishing marginal utility helps explain why people buy more when the price decreases.

A person will increase consumption as long as the marginal benefit you expect exceeds the price.

Economics Bell Ringer: Turn in your homework from last night to the

class period tray.

Reflect on the Law of Diminishing Marginal Utility and answer the following questions based on what you know! 1. Why are newspapers sold in vending machines that

allow you to take more than one copy?2. How much do you eat when you can eat all you want?3. What cures spring fever?4. What economic principle is behind the saying “been

there, done that?” Why?