1 DEMAND LECTURE II. 2 LETS LOOK AT THE COMMODITY WHEAT Price Surplus P 1 Supply P e Demand Q e...

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DEMAND LECTURE IIDEMAND LECTURE II

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LETS LOOK AT THE COMMODITY LETS LOOK AT THE COMMODITY WHEATWHEAT

Price Price SurplusSurplus

PP1 1 SupplySupply

PPee DemandDemand

QQee Quantity / unit of Quantity / unit of

timetime

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A SURPLUSA SURPLUS

A. PA. Pee and Q and Qee represent the market represent the market

clearing price and quantity.clearing price and quantity.

B. Assume the government sets a price atB. Assume the government sets a price at

PP11::

1. There is a surplus of goods.1. There is a surplus of goods.

2. Price must fall for the market to2. Price must fall for the market to

clear.clear.

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LETS LOOK AT THE COMMODITY LETS LOOK AT THE COMMODITY GASOLINEGASOLINE

Price Price

SupplySupply

PPee DemandDemand

PP22

ShortageShortage

QQee Quantity / unit of timeQuantity / unit of time

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A SHORTAGEA SHORTAGE

C. Assume the government sets a price C. Assume the government sets a price at at

PP22::

1. There is a shortage of goods.1. There is a shortage of goods.

2. Price must rise for the market 2. Price must rise for the market toto

clear.clear.

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SURPLUS AND SCARCITY?SURPLUS AND SCARCITY?

D. We could have a surplus and still D. We could have a surplus and still have a scarce commodity, RIGHT ?have a scarce commodity, RIGHT ?

1. Yes. This is due to there not1. Yes. This is due to there not

being enough goods to meetbeing enough goods to meet

demand at a price of zero.demand at a price of zero.

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DETERMINANTS OF DEMANDDETERMINANTS OF DEMAND

As a commodity's own price changes, As a commodity's own price changes, we move along the existing demand we move along the existing demand

curve. (Law of Demand)curve. (Law of Demand)

A.A. Other factors affect the demandOther factors affect the demand

curves position, shape, and curves position, shape, and slope.slope.

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These other determinants, in addition These other determinants, in addition to the commodity's own price are:to the commodity's own price are:

a. Consumer disposable income.a. Consumer disposable income.

b. Price of substitutes.b. Price of substitutes.

c. Price of complements.c. Price of complements.

d. Consumer preferences.d. Consumer preferences.

e. Expectations about the e. Expectations about the future.future.

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f. Changes in the population.f. Changes in the population.

g. Weather.g. Weather.

h. Length of adjustment period. h. Length of adjustment period.

i. Availability of substitutes.i. Availability of substitutes.

j. Proportion of the consumer’sj. Proportion of the consumer’s

budget that a particular good budget that a particular good

represents.represents.

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Consumer’s Disposable Consumer’s Disposable IncomeIncome

1. If we increase consumer's 1. If we increase consumer's disposable income ceteris paribus,disposable income ceteris paribus,

what happens?what happens?

· He/she is able to purchase · He/she is able to purchase more atmore at

all price levels.all price levels.

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2. The demand curve 2. The demand curve shifts to the right.shifts to the right.

PricePrice

DD11

DD00

QuantityQuantity

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3. If we decrease the consumer's disposable income ceteris paribus, what happens ?

· The consumer cannot purchase the same amount of the commodity as before, over the entire range of prices.

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4. The demand curve is 4. The demand curve is said to shift to the left.said to shift to the left.

PricePrice

DD00

DD11

QuantityQuantity

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5. Associated with this income effect, we can create another sub-classification for commodities:

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Normal Goods or ServicesNormal Goods or Services

An Increase in disposable An Increase in disposable income, shifts Demand curve income, shifts Demand curve right.right.

Id Id DemandDemand

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PricePrice

DD11

DD00

QuantityQuantity

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Normal Goods or ServicesNormal Goods or Services

A Decrease in disposable income A Decrease in disposable income shifts shifts Demand curve leftDemand curve left

Id Id DemandDemand

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PricePrice

DD00

DD11

QuantityQuantity

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Inferior Good or ServiceInferior Good or Service

An Increase in disposable An Increase in disposable income shifts income shifts curve left.curve left.

Id Id DemandDemand

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PricePrice

DD00

DD11

QuantityQuantity

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A Decrease in disposable income A Decrease in disposable income shifts curve right.shifts curve right.

Id Id DemandDemand

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PricePrice

DD11

DD00

QuantityQuantity

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Examples:Examples:

Macaroni and cheese dinners,Macaroni and cheese dinners, potatoes,potatoes, and riceand rice ROAD KILL !!ROAD KILL !!

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Change in the price of Change in the price of substitutes, ceteris substitutes, ceteris paribus:paribus:An increase in the price of a An increase in the price of a

substitute will result in an substitute will result in an increase in the increase in the demanddemand for the for the commodity of interest (COI) commodity of interest (COI)

(demand shifts right).(demand shifts right).

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For example, lets look at For example, lets look at beef while considering pork beef while considering pork

as a substitute:as a substitute: Let the quantity of pork available Let the quantity of pork available

become restricted. What become restricted. What happens?happens?

· There is an increase in the price of · There is an increase in the price of pork.pork.

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Increase in price of pork due Increase in price of pork due to a decrease in Supply of to a decrease in Supply of pork:pork:

Price SPrice S1 1 S S0 0 Pork MarketPork Market

PP11

PP00

DD

QQ11 Q Q00

Qd of pork/utQd of pork/ut

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There is an increase in the There is an increase in the demand for beef (COI) because demand for beef (COI) because of the increase in the price of of the increase in the price of pork (SUBSTITUTE).pork (SUBSTITUTE).

Price SPrice S0 0 Beef Beef MarketMarket

PP11

PP00

DD11

DD00

QQ00

Qd of beef/utQd of beef/ut

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D1

D0

S0

P0

P1

BEEFS1 S0

D0P0

P1

PORK

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Substitutes:Substitutes:

Therefore, an increase in the price of Therefore, an increase in the price of a substitute will shift the entire a substitute will shift the entire demand curve of the commodity of demand curve of the commodity of interest to the right.interest to the right.

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A decrease in the price of a A decrease in the price of a substitute will shift the entire substitute will shift the entire demand curve of the commodity of demand curve of the commodity of interest to the left.interest to the left.

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Immediate effect of a supply Immediate effect of a supply restriction for the substitute is a restriction for the substitute is a price increase.price increase.

This will affect the demand curve for This will affect the demand curve for the COI by increasing demand the COI by increasing demand (shifts to the right) for the COI.(shifts to the right) for the COI.

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Immediate effect of a increase in Immediate effect of a increase in supply is a price reduction.supply is a price reduction.

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PPsubsub DDCOICOI

ANDAND

PPsub sub DDCOICOI

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Reflect Back:Reflect Back:

We have talked about what has happened in agriculture when wage rates have increased. Capital and labor are substitutes for each other.

We have discussed that as the wage rate has increased, the demand for capital has increased.

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Change in the price of a Change in the price of a complement, ceteris complement, ceteris paribus:paribus:Complements are goods that go Complements are goods that go

together, such as:together, such as: left and right shoes,left and right shoes, gas and cars,gas and cars, milk and cereal,milk and cereal, bread and butter,bread and butter, guns and ammo,guns and ammo, etc.etc.

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Compliments:Compliments:

If the price of a complement If the price of a complement increases, then the demand for the increases, then the demand for the COICOI decreases. decreases.

PPcompcomp DDCOICOI

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Price Price Let the price of milk increase.Let the price of milk increase.

Since cereal is a complement of Since cereal is a complement of milk,milk,

its demand will decreaseits demand will decrease..

DD00

DD11

Qd/utQd/ut

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If the price of a complement If the price of a complement decreases, the demand for the decreases, the demand for the COI COI increases.increases.

PPcompcomp DDCOICOI

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Price Price Let the price of milk decrease.Let the price of milk decrease.

Since cereal is a complement Since cereal is a complement of milk,of milk,

its demand will increaseits demand will increase..

DD11

DD00

Qd/utQd/ut

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Consumer preferences Consumer preferences and tasteand taste

As preferences change the demand As preferences change the demand curve will also change.curve will also change.

For example: What would be the For example: What would be the result of the following statements, result of the following statements, if true, on the demand curve for if true, on the demand curve for each commodity ?each commodity ?

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Animal fat leads to a Animal fat leads to a higher risk of heart higher risk of heart attacks.attacks.

Price Price Result: Result: Demand for red meatDemand for red meat

DD00

DD11

Qd/utQd/ut

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Nitrites in bacon have Nitrites in bacon have been linked to cancer.been linked to cancer.

Price Price Result: Result: Demand for baconDemand for bacon

DD00

DD11

Qd/utQd/ut

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Increasing fiber in the diet Increasing fiber in the diet reduces the chance of reduces the chance of getting colon cancer.getting colon cancer.

PricePrice

DD11

DD00

Quantity / unit of timeQuantity / unit of time

Result: Demand for high fibercereals and popcorn.

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Trichinae can be Trichinae can be eliminated in pork by a eliminated in pork by a new irradiation processnew irradiation process

PricePrice

DD00


Result: ???????

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National Inquirer says that people National Inquirer says that people who own and care for rose bushes who own and care for rose bushes live 20 years longer than the average live 20 years longer than the average person.person.

PricePrice

DD11

DD00


Result: Demand for rose bushes

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Expectations about the Expectations about the futurefuture

The peanut butter scare: The peanut butter scare:

a news release said that the peanut a news release said that the peanut crop would be short that year and crop would be short that year and peanut butter prices were peanut butter prices were expected to double.expected to double.

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Expectations about the Expectations about the futurefuture

Result:Result:

People bought 3 lbs. of peanut butter People bought 3 lbs. of peanut butter that month instead of 1lb. that month instead of 1lb.

Demand for peanut butter.Demand for peanut butter.

Due to Expectations of higher Price.Due to Expectations of higher Price.

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Expectations: The Self-Expectations: The Self-Fullfilling Prophecy !Fullfilling Prophecy !

Since consumers expect prices to Since consumers expect prices to increase, they all run out to buy increase, they all run out to buy NOW.NOW.

This causes demand to increase, and This causes demand to increase, and prices are pushed up very quickly!prices are pushed up very quickly!

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Graphically Speaking:Graphically Speaking:PricePrice

$2.00$2.00

DD11

DD00

1 3 1 3

lbs. per lbs. per monthmonth

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NOTE:NOTE:

If the commodity we were If the commodity we were analyzing was not analyzing was not storable, then the storable, then the demand curve may demand curve may NOTNOT shift.shift.

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Changes in the population Changes in the population of consumersof consumers

PricePrice

DD11

DD00

Quantitiy/unit Quantitiy/unit timetime

Increase in population will result in increase in Demand for G&S.

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Changes in the population Changes in the population of consumersof consumers

Price Price

DD00

DD11

Quantitiy/unit timeQuantitiy/unit time

Decrease in population will result in decrease in Demand for G&S.

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Length of the Adjustment Length of the Adjustment PeriodPeriod

This is tied to, or related to the availability of This is tied to, or related to the availability of substitutessubstitutes..

PricePriceShort Run: Consumers have little time to find suitable substitues.

D

Quantity per Unit of Time

Demand is not very sensitiveto price changes, c.p.

We say demand is relatively inelastic

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Length of the Adjustment Length of the Adjustment PeriodPeriod

PricePrice

D

Quantity Demanded per Unit of Time

Long Run: Consumers have time to find suitable substitutes.

Demand becomes moresensitive to prices changesas time progresses, c.p.

We say demandis relativelyelastic.

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An Example: Demand for An Example: Demand for GasolineGasoline

If the price of gas increases from If the price of gas increases from $1.20 per gallon to $2.20 per gallon, $1.20 per gallon to $2.20 per gallon, how will consumers respond?how will consumers respond?

First:First:

Are we asking how consumers will Are we asking how consumers will respond over the next day, week, respond over the next day, week, month, year, etc. month, year, etc.

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It makes a difference!It makes a difference!

Demand for gas will be different for Demand for gas will be different for different time periodsdifferent time periods

The longer the time period considered, The longer the time period considered, the flatter the demand curve the flatter the demand curve becomes; or the becomes; or the more elastic more elastic it it becomes.becomes.

The The more responsive more responsive demand becomes demand becomes to changes in price!to changes in price!

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What Occured in the What Occured in the 1970’s?1970’s?

What was a simplified sequence of What was a simplified sequence of events that occurred when gas events that occurred when gas prices at the pump increased so prices at the pump increased so dramatically in the dramatically in the

1970's?1970's?

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The Sequence of Events:The Sequence of Events:

(1) People griped.(1) People griped.

(2) Car pools formed, and bus usage(2) Car pools formed, and bus usage

increased.increased.

(3) Big cars were replaced with small(3) Big cars were replaced with small

ones.ones.

(4) Some people moved closer to work.(4) Some people moved closer to work.

(5) New technology that decreased fuel(5) New technology that decreased fuel

consumption was developed.consumption was developed.

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What was the result of this What was the result of this sequence of events on sequence of events on Demand?Demand?

Price

Quantity demanded

$1.20

$2.20

Q1 Q0

In Short Run, the very large increasein gas price resulted in a very small decrease in consumption of gasoline.

D

Consumption of gas will not be veryresponsive to the increase in price.

We say demand is relatively inelastic

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As time progressed:As time progressed:As time progressed:As time progressed:

Price

Quantity demanded

$1.20

$2.20

Q1Q0

In Long Run, consumers have time tofind substitutes, and the very largeincrease in gas price will eventuallyresult in a significant decrease inconsumption of gasoline.

This of course assumes that consumers perceive the increasedprice of gas to be persistant, not just a temporary price increase.

D

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The Availability of The Availability of SubstitutesSubstitutes

D

Price

Quantity/unit time

If a commodity has FEW substitutes,demand for the commodity will tendto be more inelastic or less responsiveto price changes.

P0

P1

Q1 Q0

Demand curve will tend to have avery steep slope.

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D

Price

Qd/unit time

If a commodity has MANY substitutes,demand for the commodity will tendto be more elastic or more responsiveto price changes.

P0

P1

Q1 Q0

The Availability of The Availability of SubstitutesSubstitutes

Demand will tend to havea very flat slope.

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Proportion of the Consumers Proportion of the Consumers Budget a Good or Service Budget a Good or Service

RepresentsRepresents

D

Price

Qd/u.t.

Salt

$.50

$1.00

Q0Q1

If the price of SALT doubles, how muchwill this price increase affect the consumptionof salt?

Why?

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RepresentsRepresentsThe less of a consumers budget a The less of a consumers budget a

commodity represents, the morecommodity represents, the moreinelasticinelastic the demand curve will the demand curve will

tend to be.tend to be.

The price of salt is such a small The price of salt is such a small percentage of our budgets, that percentage of our budgets, that consumption of salt will not be affected consumption of salt will not be affected very much by a price increase.very much by a price increase.

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RepresentsRepresents

D

Price

Qd/u.t.

Automobile

$20,000

$40,000

Q0Q1

If the average price of an AUTO doubles,how much will this price increase affect theconsumption of Automobiles?

Why?

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RepresentsRepresentsThe more of a consumers budget a The more of a consumers budget a

commodity represents, the morecommodity represents, the moreelasticelastic the demand curve will tend the demand curve will tend

to be.to be.

The price of an automobile is such a The price of an automobile is such a large percentage of our budgets, that large percentage of our budgets, that consumption of automobiles will be consumption of automobiles will be affected very much by a price increase.affected very much by a price increase.

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Automobile Prices:Automobile Prices:

Business Week reported on Feb. 7, 1994 Business Week reported on Feb. 7, 1994 that the 1993 average price of a car wasthat the 1993 average price of a car was

$18,100$18,100

This was a 69% increase from 1983. This was a 69% increase from 1983. What was the average price of a car in What was the average price of a car in 1983?1983?

$10,710$10,710

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Real Price of a Car?Real Price of a Car?

Based on median household income:Based on median household income:

In 1983, it required 22 weeks of In 1983, it required 22 weeks of wages to purchase a new car.wages to purchase a new car.

In 1993, it required 26 weeks of In 1993, it required 26 weeks of wages to purchase a new car.wages to purchase a new car.

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Real Price of a Car?Real Price of a Car?

What did the real price of a car do What did the real price of a car do between 1983 and 1993 based on between 1983 and 1993 based on median household income?median household income?

It Went Up!It Went Up!

1 DEMAND LECTURE II. 2 LETS LOOK AT THE COMMODITY WHEAT Price Surplus P 1 Supply P e Demand Q e...

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