Transcript Chapters 4 5

Demand
An Examination of the Factors
that Influence the Demand
for a Product
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Demand
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Definition
Demand is the number of units of a good or
service that consumers are willing to
purchase at any given market price at any
given time.
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Demand
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Demand
The demand for any good can be measured
using market research.
This demand can then be displayed or
shown in a number of different ways …
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Demand
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1. Bar Chart
Bar chart showing the demand for product X
20
15
10
5
0
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€1
€2
€3
€4
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2. Demand Schedule
A demand schedule is a table showing the number
of units of a good or service that consumers are
willing to purchase at any given market price at
any given time.
Price
€1
€2
€3
€4
€5
Quantity
50
43
34
26
22
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3. Demand Curve
A demand curve is a graph
showing the number of
units of a good/service that
consumers are willing to
purchase at any given
market price at any given
time.
Price
D
Demand curve
€4
€3
€2
This is the method most
frequently used to display
demand.
€1
D
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28
36
43
50
Quantity £
$
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Individual and Market Demand
The market demand for a product is the sum of all the
individual demand schedules for that product.
Assume that there are only two consumers of product X:
Joe and Mary. Their combined demands make up the
market demand.
Price
Joe’s demand
Mary’s demand
Market demand
€1
20
30
50
€2
18
25
43
€3
17
17
34
€4
15
13
28
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£
$
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Demand
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Utility
Utility is the amount of benefit or
satisfaction derived from the consumption of
a good or service.
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Marginal Utility
Marginal utility is the addition to total utility brought
about by the consumption of
an extra unit of a good.
Total utility
from 1 unit
800
Total utility
from 2 units
1300
Total utility
from 3 units
1600


MU of
second unit
MU of third
unit
= 500
= 300
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Demand
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An Economic Good
An economic good is any good or service that people
are willing to pay for.
That is, it is a good or service that can command a
price.
Characteristics of an economic good:
 It must give utility.
 It must be scarce in relation to the demand for it.
 It must be transferable.
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Assumptions Made About Consumers
1.
2.
3.
4.
They act rationally.
They have limited incomes. (Most people do not have
enough income to satisfy their wants.)
They aim to get maximum utility from the way they
spend their incomes.
They are subject to the law of diminishing marginal
utility.
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Law of Diminishing Marginal Utility
This law states that as a consumer consumes additional
units of a particular product, at some stage the marginal
utility derived from the consumption of that product will
begin to decrease.
Quantity
Total Utility
Marginal Utility
1
500

2
900
400
3
1200
300
4
1400
200
5
1500
100
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The Law of Diminishing Marginal Utility Assumptions (1)
It applies only after a certain point called the origin.
The origin is the minimum quantity of a good that can
be used effectively and MU does not decrease until
this quantity is consumed.
Example: MU does not apply after the first spoonful
from your morning bowl of cereal; it applies only after
the first bowl (depending, of course, on the size of the
bowl!).
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The Law of Diminishing Marginal Utility Assumptions (2)
It assumes that the total utility of a good is not fully
used up before the next unit is consumed.
If you eat a bar of chocolate today and do not eat
another until this day next week, the MU will not
decrease because the total utility from the first bar is
fully used up before you consume the next one.
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The Law of Diminishing Marginal Utility Assumptions (3)
It assumes that income does not change.
As income rises MU may not fall as consumption
increases.
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The Law of Diminishing Marginal Utility Assumptions (4)
It does not apply to addictive goods or to medicines.
With these goods MU may remain constant or it may even
increase as consumption increases.
Example:
Each extra tablet from a prescribed course of medication
may bring increased MU until the last tablet is taken.
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Equilibrium
In economics the term equilibrium refers to the ideal
situation to be in, under any given set of
circumstances.
For a consumer this means that he/she is getting the
maximum possible utility from his/her income.
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The Principle of Equi-Marginal Utility
This principle states that a consumer will be in
equilibrium when he or she spends his or her income
in such a way that the ratio of marginal utility to price
is the same for all goods purchased.
MU(A)
P(A)
MU(B)
=
P(B)
MU(C)
=
and so on …
P(C)
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Proof of the Principle of Equi-MU (1)
Assume that an individual has an income of €80 per week
which he spends on two products, X and Y.
X is priced at €20 and Y is priced at €10 .
The utilities derived from these products are as follows.
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Proof of the Principle of Equi-MU (2)
Product X (€20)
Quantity
TU
MU
Possible combinations of purchase:
Quantity
Utilities
Combined TU
4X + 0Y
3100 + 0
3100
1
1000
2
1800
800
3X + 2Y
2500+ 2600
5100
3
2500
700
2X + 4Y
1800 + 3500
5300
4
3100
600
1X + 6Y
1000 + 4000
5000
0X + 8Y
0 + 4150
4150
Product Y (€10)
Quantity
TU
MU
The combination that gives the
maximum utility is 2X + 4Y.
1
2000
2
2600
600
3
3100
500
4
3500
400
5
2800
300
6
4000
200
7
4100
100
£
8
4150
50
$
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The MU of 2X is 800 and its price is
€20, giving a ratio of 40:1.
The MU of 4Y is 400 and its price is
€10, giving a ratio of 40:1.
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1. Make out utility figures for X: make sure that the MU is
decreasing.
2. Pre-decide what combination of the two goods will be
purchased, e.g. 2X + 4Y.
3. The MU of 2X is 800, thus the MU of 4Y will have to be
400  it is half the price of X.
4. Put in the MU of 4Y.
5. Fill in the utility figures for 3Y, 2Y and 1Y, ensuring that
the MU is increasing as you go backwards.
6. Start filling in the utilities from 4Y onwards ensuring
that MU is decreasing.
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Manipulation of Proof
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Demand
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Manipulation of Proof, cont.
Possible combinations of purchase
X
We Product
are using
the same utility figures and income as before.
Qty
TU
1
1,000
2
1,800
3
4
MU
Utilities
Combined TU
4X + 0Y
3,100 + 0
3,100
800
3X + 2Y
2,500 + 2,600
5,100
2,500
700
2X + 4Y
1,800 + 3,500
5,300
3,100
600
1X + 6Y
1,000 + 4,000
5,000
Product Y
Qty
TU
MU
0X + 8Y
0 + 4,150
4,150
1
2,000
2
2,600
600
3
3,100
500
4
3,500
400
5
3,800
300
6
4,000
200
7
4,100
100
8
4,150
50
You want 2X and 4Y to give the maximum utility.
The MU of 2X is 800, therefore the MU of 4Y must be half of
Now
fill out
any
utility
figures
for
thedecide
most expensive
product.
Before
youY
make
out
any
figures,
which combination
that
because
is half
the
price
of X.
wantastothe
give
the
utility, e.g. 2X and 4Y. Do not
Putyou
in 400
MU
ofmaximum
4Y.
a quantity
zero
Now fill in take
the other
figuresoffor
Y: or 1 of either product
• the MU must increase as you go backward
• and decrease as you go forward.
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Manipulation of Proof, cont.
Possible combination of purchase
Product X
Qty
TU
1
1,000
2
1,800
3
4
MU
Utilities
Combined TU
4X + 0Y
3,100 + 0
3,100
800
3X + 2Y
2,500 + 2,600
5,100
2,500
700
2X + 4Y
1,800 + 3,500
5,300
3,100
600
1X + 6Y
1,000 + 4,000
5,000
Product Y
Qty
TU
MU
0X + 8Y
0 + 4,150
4,150
1
2,000
2
2,600
600
3
3,100
500
4
3,500
400
5
3,800
300
6
4,000
200
7
4,100
100
8
4,150
50
The combination which gives the maximum utility is 2X + 4Y.
The MU of 2X is 800 and its price is €20, giving a ratio of 40:1.
The MU of 4Y is 400 and its price is €10, giving a ratio of 40:1.
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Demand
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Proving that When P Goes Up D Goes Down
New possible combinations of purchase
Assume the same income and the same utility figures
Combined
Qty
TU
MU
except that the price of Y increases to Utilities
€20.
Utilities
Product X @ €20
1
1,000
2
1,800
800
3
2,500
4
3,100
4X + 0Y
3,100 + 0
3,100
700
3X + 1Y
2,500 + 2,000
4,500
600
2X + 2Y
1,800 + 2,600
4,400
1X + 3Y
1,000 + 3,100
4,100
0X + 4Y
0 + 3,500
3,500
Product Y @ €20
Qty
TU
MU
1
2,000
2
2,600
600
3
3,100
500
4
3,500
400
The combination that now gives the highest TU is
3X and 1Y.
Thus, when the price of Y increased, its demand went
down from 4 units to 1 unit.
Note that this is the only conclusion to be
drawn from the increase in the price of Y.
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Demand
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Factors Influencing Demand for a Product
The main factors that govern people’s demand for goods
on a day-to-day basis are:
 The price of the good itself (P1).
 The person’s income (Y).
 The price of other goods (Pog).
 The person’s taste (T).
Thus:
D = f ( P1, Y, Pog, T )
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Factors Influencing Demand for a Product
Other factors that influence demand are:
 The price and availability of credit (Cr).
 Consumers’ expectations (E).
 Government regulations (G).
 Unforeseeable factors (U).
Thus:
D = f ( P1, Y, Pog, T, Cr, E, G, U )
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Price
An increase in the price of
a product …
causes a contraction in
demand.
That is, less of the
product is purchased as a
direct result of an
increase in price.
Price
D
€5
D
€3
30
Quantity
100
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£
$
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Extension in Demand
A decrease in the price of
a product …
causes an extension in
demand.
That is, more of the
product is purchased as a
direct result of a decrease
in price.
Price
D
€5
D
€3
30
Quantity
100
€
£
$
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Demand
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The Substitution Effect
The effect that a change in the price of a good has on the
demand for that good is called the substitution effect.
It assumes no change to any other factor that affects
demand.
It is always positive in that it will always react in the same
way.
That is, a decrease in the price of a product causes an
extension in demand, and an increase causes a contraction
in demand.
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Movements Along a Demand Curve
Extension in demand
Contraction in demand
D
P1
D
A
P2
B
P2
B
A
P1
D
D
Q1
Q2
Q2
Q1
These are sometimes called movements along a demand curve as
demand shifts from point A to point B along the same curve.
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Income
In economics the term income is used to describe
purchasing power.
The full term is
real income.
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Real Income
 Real income is the purchasing power of money
income.
 Real income will change when there is any
change in the relationship between money
income and prices.
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Real Income
Example:
 Your money income is €200 a week.
 The price of product A is €20 per unit. At this price you
can purchase 10 units of A (a ratio of 10:1).
 Your money income remains at €200, but the price of A
increases to €40. You can now purchase only 5 units of
product A each week (a ratio of 5:1).
 Your real income has decreased because your
purchasing power has decreased.
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Changes in Real Income
Some ways in which real income can increase:
 Money income remains unchanged when prices
decrease.
 Money income increases while prices remain
unchanged.
 Money income increases by a greater percentage
than the percentage increase in prices.
 Money income decreases by a smaller percentage
than the percentage decrease in price.
Reverse these for decreases in real income.
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Positive / Negative Income Effect
 A positive income effect occurs when demand
changes in the same direction as the income
change. This always applies to normal goods.
 A negative income effect occurs when demand
changes in the opposite direction to the income
change. This always applies to inferior goods.
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Decrease in Demand
A decrease in demand
means that less of the good
is demanded at any given
market price.
A decrease in income is one
of the causes of this
decrease in the demand for
normal goods.
Price
D1
D2
€5
D1
D2
100
200
Quantity
€
£
$
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Increase in Demand
An increase in demand
means that more of the
good is demanded at any
given market price.
An increase in income is one
of the causes of this
increase in the demand for
normal goods.
Price
D2
D1
€5
D2
D1
100
200
Quantity
€
£
$
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Inferior Good
An inferior good is one that
has a negative income
effect.
As income increases, the
demand for inferior goods
decreases.
Price
D1
D2
€5
D1
D2
The reverse of this happens
if income decreases. That is,
the demand for inferior
goods would increase.
Q2
Q1
Quantity
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£
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Movement of a Demand Curve
An increase or a decrease in demand is often referred to as a
movement of a demand curve.
D1
Price
Decrease
D2
Price
D2
Increase
D1
D1
D2
D2
Q2
Q1
Quantity
D1
Q1
Q2
In both situations the position of the D curve has moved.
Quantity
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The Full Price Effect
The price of a product changing and money income
remaining the same has two effects on demand:
1. the substitution effect
–
–
due to the price change.
The effect is always positive.
2. the income effect
–
–
because the price has changed but the money
income has not changed.
The effect can be positive or negative.
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The Full Price Effect
Thus we could have a positive substitution effect combining
with either:
 a positive income effect, or
 a negative income effect.
Positive substitution effect + positive income effect
= a normal good
Positive substitution effect + weaker negative income effect
= an inferior good
Positive substitution effect + stronger negative income effect
= a Giffen good
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The Full Price Effect
Example:
P1 = €1 and Q1 = 100: Money income = €200
P2 = 80¢ and money income remains unchanged
Substitution
Income
+
effect
effect
=
Full price
effect
+30
+
+20
=
+50
(Normal)
D goes up by 50
+30
+
20
=
+10
(Inferior)
D goes up by 10
40
10
=
(Giffen)
+30
+
€
D goes down by 10
£
$
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Summary
A normal good has a
positive substitution effect
and a positive income
effect.
An inferior good has a
positive substitution effect
and a weaker negative
income effect.
A Giffen good has a
positive substitution effect
and a stronger negative
income effect.
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Demand curve for a Giffen good
Price
D
D
Quantity
This is sometimes called a
perverse demand curve.
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Demand
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Pog (1) Substitute Goods
Substitute goods are two or more different
goods that can be substituted for each other
to satisfy any one need or want.
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Substitute Goods
When the price of a good decreases it makes its substitute product
relatively more expensive. Therefore, many consumers will switch their
demand away from the substitute good. Assume tea and coffee are
substitutes for each other.
Price
Tea
D
Price
Coffee
D
D2
€2
€2
€1
D
D
Q1
Q2
Quantity
D2
Q2
Q1
Quantity
Therefore, a decrease in the price of a product causes a decrease in
the demand for its substitute and vice versa.
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Summary
The D for two goods that are substitutes for
each other will always change in opposite
directions when there is a change in the
price of one of them.
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Complementary Goods
Complementary goods (goods in joint demand) are
two or more different goods that must be purchased
together to satisfy any one need or want.
For example:
 darts and a dart board
 a padlock and a key
 knives and forks
 cups and saucers.
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Complementary Goods
 The purchase of two complementary goods is
normally regarded as one transaction.
 Thus if the price of one of the goods changes
it changes the cost, or price, of the
transaction.
For example …
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Complementary Goods

If the price of a lock is €3 and the price of a key is €1, then the cost (price) of a lock
and key is €4.

If the price of the key increases to €2 and the price of the lock remains at €3, the
cost (price) of the transaction rises to €5 and fewer locks and keys will be purchased.
Keys
Price
D
Price
Contraction in
demand
D2
D
Locks
Decrease in
demand
€3
€2
D2
€1
D
D
Q2
Q1
Quantity
Q2
Q1
Quantity
When the price of one good increases it causes a decrease in the demand for its
complement and vice versa.
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Demand
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Goods in Derived Demand
A good is in derived demand when it is not purchased
for its own direct utility but for the additional utility
that it gives to some other product.
For example:
 The demand for blocks is derived from the demand
for buildings.
 The demand for tickets is derived from the demand
for entertainment.
 The demand for air transport is derived from the
demand for foreign holidays and business visits.
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Goods in Derived Demand
The demand for blocks is derived from the demand for houses. If the
price of houses decreases this will cause an extension in the demand
for houses and an increase in the demand for blocks.
House
price
(€Ms)
D
Houses
Block
price
(€s)
Extension in
demand
P
D1
D2
Blocks
Increase in
demand
P1
D2
P2
D1
D
Q1
Q2
Quantity
Q1
Q2
Quantity
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£
$
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The Consumers’ Tastes
 Tastes reflect marginal utility.
 If tastes change in favour of a product it indicates an increase
in MU.
 When MU increases we demand more of the good without its
price changing.
 Therefore, a change in taste in favour of a product causes an
increase in demand.
 If tastes change against a product it indicates a decrease in MU.
 When MU decreases we demand less of the good without its
price changing.
 Therefore, a change in taste against a product causes a decrease
in demand.
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The Price and Availability of Credit
 When interest rates are decreased this causes a reduction in
the real cost of any good that is purchased on credit. This
results in more of these goods being demanded.
Interest rates go down
Demand goes up
 Normally it applies only to expensive consumer durables.
 Likewise, if credit was not available fewer expensive
consumer durables would be purchased – that is, it would
cause a decrease in the demand for them.
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Consumers’ Expectations
If consumers believe that a product may become
scarce in supply in the not too distant future, they may
increase their demand for that product to ensure that
they have an ample supply of it for the immediate
future. Thus they buy more of it without its price
changing.
This will cause an increase in demand.
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55
Government Actions/Regulations
Governments can undertake advertising campaigns or
introduce legislation that can result in a change in
demand for a product.
For example:
 The government’s smoking ban has resulted in a
decrease in demand for cigarettes.
 Likewise, the government places high taxes on cars,
causing a contraction in their demand.
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Demand
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Unforeseeable Factors
Sometimes unpredictable events occur, which can
affect the D for a product.
When these occur they cause either an increase or
a decrease in demand.
For example:
A livestock disease can cause a decrease in
demand for meat and an increase in demand for
mats and disinfectant.
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Exceptions to Law of Demand
 Giffen goods – when the price goes up the D goes up, e.g.
staple foods such as bread.
 Goods for which prices are affected by consumers’
expectations, e.g. shares or commodities – if these go up in
price people buy more in the hope of selling later at an even
higher price.
• Goods of conspicuous consumption (“snob goods”). These are
products that are purchased by some people to enable them
to display their wealth, e.g. top-of-the-range cars, expensive
designer clothes. This usually occurs over a certain price
range only.
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Exceptions to Law of Demand
Demand curve for goods of conspicuous /
ostentatious consumption
Price
D
Normal D curve
Perverse D curve
Normal D curve
D
£
Quantity
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The Paradox of Value
 Some products have a high value in exchange
(price), but have a low value in use.
– For example: diamonds.
 Other products have a low value in exchange but a
high value in use.
– For example: water.
Thus, water, which is vital for our existence, is cheap,
while diamonds, which are a luxury, are expensive.
This is an apparent contradiction in terms – that is, a
paradox.
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Paradox of Value
Water has a high total
utility but it has a low
marginal utility.
Diamonds have a lower
total utility than water,
but they have a higher
marginal utility.
Quantity
20
21
TU
5,000
5,100
MU

22
5,150
100
50
Quantity
TU
MU
1
600

2
900
300
3
1,150
250
Value is based on marginal utility.
Understanding Economics, © Richard Delaney, 2008, Edco
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